Semiconductor stocks have done very well since November amid booming demand and pandemic-induced supply constraints. Yet after solid year-to-date performance, investors appear wary of any hint of a slowdown and an end to the current boom phase of this cycle.
After several sector bellwethers recently reported earnings, semiconductor stocks took a bit of a dip. Management from Taiwan Semiconductor Manufacturing (NYSE:TSM), Intel (NASDAQ:INTC), and Texas Instruments (NASDAQ:TXN) all pointed to some easing of the current shortage in the most heavily affected auto chip sector. However, autos are only a small portion of industry, so it's misguided for investors to focus solely on that. Other comments pointed to continued demand strength that could last well into this decade, especially for leading-edge chips.
That's why the recent pullback may be short-lived, so investors may want to use the current weakness to pick up some shares of their favorite chip stocks.
Some auto constraints are easing, and the shortage may be "bottoming"
Taiwan Semiconductor, the largest foundry in the world, greatly increased its output of automotive chips last quarter, up 12% over the prior quarter, helping to ease the shortage of automotive microcontrollers (MCUs) that caused widespread shortages and work stoppages at global carmakers. TSM management now says the company is on its way to increasing its auto chip capacity by 60% this year. "We expect the automotive component shortage from semiconductor to be greatly reduced for TSMC customers starting this quarter," management said on its most recent earnings call.
At the same time, Texas Instruments, which gets a much bigger proportion of its revenue from automotive chips, handily beat expectations last quarter, as auto-related chips more than doubled over the prior year. Yet management's guidance only pointed to flat to slightly higher sequential growth, in what is normally a stronger seasonal quarter for the company.
Finally, Intel management also said shortages will "bottom out" later this year, and it reported 124% year-over-year growth in its Mobileye autonomous car unit.
But don't get scared out of semis
With the easing of auto chip shortages, investors may be nervous that we are getting to the end of shortages more broadly. With multiple companies announcing big capacity increases over the next few years, some might think the industry is at a greater risk of oversupply -- and another "bust."
However, I think it would be a big mistake to sell semi stocks, which should continue to do quite well, even from these higher levels.
First, while Texas Instruments' guidance may have disappointed some, management attributed some of this to the lack of seasonality in the unique COVID-19 recovery environment:
Normal seasonal patterns may not be the best measure to look at things in periods like this. ... [T]he last few quarters have been exceptionally strong. Second quarter was certainly strong both sequentially and year-on-year. So if you look at our guidance, it would suggest that next quarter will again be a very strong quarter.
Texas Instruments also blew away the high end of its guidance last quarter, so the rather tepid sequential guidance may also just be conservatism in this uncertain environment.
Meanwhile, both Intel and Taiwan Semi gave extremely positive projections about non-auto chip demand, both in the short and long term.
A new age of semiconductors
While Intel did say it saw current shortages "bottoming" in the second half, that doesn't mean the broader industry shortage will end at that time, just that it won't get worse. CEO Pat Gelsinger elaborated, "While I expect the shortages to bottom out in the second half, it will take another one to two years before the industry is able to completely catch up with demand."
One to two years is a long time, and if that's true, it would be far too early to jump off the semiconductor train. Gelsinger said he's even seeing the PC market, which boomed during the pandemic, continue to expand beyond 2022, due to new hybrid and work-from-home arrangements. Couple that with the accelerated digitization of the economy more broadly, and Gelsinger thinks we are still in the "early innings of what is likely to be a decade of sustained growth across the industry."
Those incredibly bullish comments were echoed by Taiwan Semi. While the auto sector may get back into balance somewhat soon, auto chips generally rely on older nodes that are easier to ramp up. Meanwhile, Taiwan Semi is still struggling to keep pace with massive demand it's seeing for leading-edge technologies that go into new-age applications like 5G and artificial intelligence computing. Management also told investors that the company will likely grow at the high end of its long-term 10% to 15% annual growth rate, with even higher growth this year. Like Intel, Taiwan Semi sees a "structural" increase in semiconductor demand fueling shortages for the rest of this year and "at least" into 2022.
But perhaps the most important part of the leading-edge technology story isn't just the current demand strength, but also that it could even out historical volatility the semiconductor industry has seen in the past. CEO C. C. Wei importantly said, "Even [if] inventory correction [were] to occur, we believe it will be less volatile than previous downturn as our underlying structural megatrend of 5G-related and HPC [high-performance computing] application will continue."
Are semis turning into growth stocks?
Semiconductors have been subject to violent corrections in the past, most recently in 2018, which causes chip stocks to largely trade at a discount to other more consistent tech sub-sectors such as software. Yet remember, the 2018 downturn was triggered by the onset of the U.S.-China trade war -- a huge geopolitical event that may not happen again, or at least to the same degree. And if the underlying trends of 5G and high-performance computing limit volatility even further, semiconductor, memory, and semi equipment stocks could garner a valuation rerating higher.
In short, investors should probably stop playing the cycles and stick with semis over the long term this decade, even if the prominent auto chip shortage is easing.