The auto industry has had a rough go of it over the past few years. After a mini-recession resulting from the U.S.-China trade war sent auto sales down 1.4% last year, the COVID-19 pandemic put a big dent in sales this year as people quarantined and couldn't get to dealerships.
Yet as people continue to avoid public transportation or ride-hailing companies, Americans appear to be turning to owning their own cars again, either used or new. After April auto sales were basically cut in half from pre-COVID February levels, auto sales have experienced a bounceback and have nearly recovered back to pre-COVID levels as of August.
Nevertheless, many automakers still face significant challenges, especially as the world turns to electric vehicles at an accelerating pace. That's why the best way to play a recovery in autos may not be the automakers themselves, but rather these high-tech suppliers.
Auto-focused semiconductor plays
Even if a newly made car or truck isn't autonomous, the most up-to-date car features require more and more semiconductor content. Advanced driver assistant systems (ADAS), electrification, interactive displays, and other tech-enabled safety measures are being adopted with every passing year, and as autos move from Level 1 to Level 4 autonomous driving over the coming decade, those trends will only accelerate.
That's why the best way to play a recovery in autos may come from auto-focused semiconductor companies, which will get not only a bump from more auto units moved, but also a "double bump" from increased content per vehicle.
That's why auto-focused semiconductor stocks NXP Semiconductors (NXPI), ON Semiconductors (NASDAQ:ON), and Texas Instruments (NASDAQ:TXN) each look like very promising ways to play the auto recovery that's just getting under way.
NXP Semiconductors just preannounced a positive earnings surprise
First up is NXP Semiconductors, which has perhaps the largest exposure to the auto industry of any semiconductor company. In 2019, 47% of NXP sales went to the auto industry -- and remember, that was in a down year for autos. NXP fills in the rest of sales with secure identification chips for mobile payments, Internet of Things devices, Wi-Fi, and radio-frequency power solutions.
Things are looking up for NXP, as the company just preannounced third quarter results above its previous guidance. The company now believes sales will come in at $2.27 billion, versus previous guidance of $2 billion, with adjusted (non-GAAP) operating income of $586 million versus previous guidance of $444 million. Management said:
[W]e experienced material improvement in demand across all end markets, but particularly in the Automotive and Mobile end markets. Additionally, demand improved in both our direct and distribution channels. The business environment has improved at a faster than anticipated pace, driving a broad-based increase in revenue, which also enabled higher gross margin.
Look for the good times to continue should the auto market continue to move higher; meanwhile, NXP's other markets should continue to grow over the next decade as well.
ON Semiconductors has big auto exposure and a newly invested activist investor
A second auto-focused semiconductor company is ON Semiconductor. ON is a relatively small company in the semiconductor space, with a market cap of just $10.9 billion. It has also lagged many other similar semi companies in the recent past, making it a target for value investors.
In fact, activist investor Jeff Smith's Starboard Value Fund just took a position in the company and has outlined a clear path for improvement. Starboard's plan involves having ON decommission its in-house fabrication plants and outsource most production to a third-party foundry. Running one's own manufacturing can have some advantages, but when times get tough, the high fixed costs of operating a factory can lead to lower margins, and they require higher capital expenditures. In Starboard's eye, other peers that have switched to a "fab-lite" model enjoy greater margin and flexibility in down-cycles, which we've just had. Starboard believes such a move would not only lead to an increase in margins and profits but also earn ON Semi a valuation bump from investors, resulting in a "double tap" effect that should lead to a higher stock price.
Even better, ON has a solid outlook over the long term, fueled by a 33% exposure to autos, its largest end market. The good news is that as vehicles move from yesterday's "standard" features to Level 2 autonomy, ON's content per vehicle goes up 15 times, from $10 to $150. And for Level 4 vehicles with fully autonomous capabilities, but the ability for the driver to still intervene, ON's content could grow to $1,000 per vehicle.
The prospect of improving end markets and company-level improvements that Starboard is seeking could mean good things for ON's shareholders in the years ahead.
Texas Instruments: A blue chip that keeps on raising its dividend
Finally, one of the biggest and oldest blue-chip semiconductor companies also has big exposure to the auto market: Texas Instruments. This is a large and diverse semiconductor company that operates across a broader array of industries than any of its peers.
Yet for such a diverse chipmaker, 21% of sales still went to the auto market in 2019, reflecting a years-long strategic decision to focus on analog chips and embedded processors for the auto segment. The company's wide array of auto-focused chips makes Texas Instruments poised to gain from increased auto electronification this decade.
Despite an industrial recession last year and the pandemic in the first half of 2020, the dependable Texas Instruments still managed to generate $5.7 billion in free cash flow for the 12 months ended in June, allowing the company to continue repurchasing stock and paying its dividend even in hard times. In fact, the company just raised its dividend by 13% in September and now yields a hefty 2.75%.
Texas Instruments' scale and sterling record of capital allocation make it the rare semiconductor stock that tech investors can buy and hold without worry for decades. That 2.75% yield isn't too shabby in a world of zero interest rates, and since that payout is all but guaranteed to rise in the future, dividend growth investors would be hard-pressed to find a better risk-reward than TI today, especially as the automotive market recovers.