The U.S.-China trade war, the coronavirus pandemic, and a sudden spike in demand for tech hardware have caused a shortage of semiconductors. That shortage is a real problem for many manufacturers this year. But for chip companies, there could be worse problems.
A shortage of tech's most basic building blocks means higher selling prices for what is available and plenty of outlets for new sales. Given the situation, chip fabrication stocks are a buy in my book for 2021. Two of the top plays in this space are NXP Semiconductors (NXPI 2.65%) and Intel (INTC 2.20%), but one of them looks like a more timely purchase at the moment.
Boomtime for digital connectivity
NXP may not be the household name Intel is, but it is nonetheless a giant in the semiconductor industry. The company is valued at a market cap of $58 billion as of this writing and has hauled in $8.6 billion in sales over the last trailing 12-month stretch via its integrated chip design department and manufacturing facilities.
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NXP makes an array of hardware for smartphones and communications networks, industrial applications, and smart-home devices. But it's the auto industry that comprises some 40% of the company's sales. That wasn't a great place to be last year when auto sales plunged more than 15%. However, as NXP focuses on chips that enable connectivity, revenue is ramping up quickly. Many modern cars have an electric drivetrain, advanced driver assist system (ADAS) features making their way to self-driving functionality, and a range of connected options to help a driver pair their smartphone to stay in touch with others on the go.
This is turning into a boon for NXP. After a short drought last spring and summer, 2020 fourth-quarter revenue increased 9% year over year to $2.5 billion. And as it gets bigger, the company is reaching a more efficient scale. Adjusted operating income thus increased 11% in Q4 to $764 million. And with the global shortage of semiconductors acting as a tailwind, NXP is in a good spot right now. Sales are expected to increase 26% at the midpoint of guidance for the first quarter of 2021. Add in the fact the company will be lapping depressed financial results that started during the pandemic lockdown last spring, and NXP will likely be in strong growth mode throughout the upcoming year.
NXP also just boosted its quarterly dividend payout by 50%. Currently, shares yield an annualized 1.1%. Add in a new $2 billion share repurchase plan (in addition to the $625 million it had remaining on its previous plan), and this is a solid tech income stock. Shares trade for a premium 31 times trailing 12-month free cash flow, but it's not unreasonable given the strong growth NXP expects to generate.
Kong strikes a blow, but Chipzilla counters
Chipzilla (Intel) has been under duress. Numerous other companies are trying to supplant Intel's chip design leadership, and Taiwan Semiconductor Manufacturing (TSM +0.40%) already surpassed Intel's manufacturing size and prowess years ago. In spite of imperfections, though, Intel is still the semiconductor firm to beat. Intel's revenue was $78 billion in 2020, an 8% increase over 2019 -- although sales did slide 1% during the final quarter of the year.
Some improvements need to be made, though, especially in its manufacturing operation. Sinking $20 billion into new fabrication facilities in Arizona will help, as will allocating some of the new capacity to making chips for those semiconductor firms that only design silicon and outsource manufacturing (the exclusive function that TSMC concerns itself with). Intel could get some help from the federal government, too. The Biden administration's $2 trillion infrastructure plan allocates funds to boosting America's chipmaking industry to create modern jobs for the 21st century.
But it could take time for Intel's investment to pay off. Case in point: Where other firms are predicting big year-over-year increases to kick off 2021, Intel is predicting a decline. Q1 revenue was forecast to be down 6% to $18.6 billion. The saving grace is that Intel will remain a highly profitable tech behemoth, anticipating an operating profit margin of 27% (compared to 35% in Q1 2020).
It's been rough going for Intel lately, but shares have rallied off of multi-year lows in anticipation of the company pulling off its counterstrike against the dozens of companies trying to take some of its market share. As of this writing, the stock trades for just 13 times trailing 12-month free cash flow, although that metric could deteriorate as the company spends to build new fabrication facilities. It also yields a 2.1% yearly dividend, not bad for a tech stock. If rebound stories are up your alley, Intel fits the bill.
Which is the better buy?
Intel could very well be a screaming value at these levels -- but only if it can regain some growth as the semiconductor industry becomes increasingly important in a new digital era. This story will take time to play out, and the company could lose more market share to its competitors in the meantime.
By contrast, NXP is benefiting from the global chip shortage and is anticipating strong double-digit growth this year. Shares are more "expensive," but they reflect expanding sales and a rising bottom line as NXP reaches a more profitable scale. It also has significant exposure to the evolving auto industry and has a hand in trends like vehicle electrification and autonomy. At this juncture, I think NXP is the better buy.
