Stories about the impact of constrained supply chains on the global economy are rampant right now, but NXP Semiconductors (NXPI +5.11%) stock is re-approaching all-time highs after its third-quarter 2021 earnings update. Revenue was up 26% year over year to $2.9 billion, and adjusted operating income was up 64% to $959 million.
Supply chain issues are having an especially deep impact on the automaking industry, which made up about half of NXP's sales last quarter. NXP grew anyways, however, because it was lapping depressed results from this same period last year, and also because the share of electronic components used in finishing a vehicle has increased dramatically. Supply chain constraints are expected to last through 2022 and perhaps into 2023, but this semiconductor designer and manufacturer could continue to expand at a healthy rate in spite of its problems.
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A study in auto industry supply chains
"Supply chain issues" is the hot topic this earnings season, and NXP was no exception. CEO Kurt Sievers talked extensively about how chip supply shortages impacted the company on the Q3 earnings call, shedding some light on the complex processes the auto industry employs to source parts. According to Sievers:
This extended supply chain needs to coordinate the timing and delivery of up to 30,000 parts and up to 1,500 different semiconductors from hundreds of suppliers to build just one single car. During normal periods, from the time at which NXP ships the finished component to when the final assembly is fitted into a finished car, it takes up to six months, and this is on top of the semiconductor manufacturing cycle times of three to six months.
This is no "normal period" of time, though. After global auto sales declined in 2019 and 2020, the pandemic exacerbated electronics supply constraints that arose as a result of the U.S.-China trade war that heated up in 2018. Basically, there wasn't enough supply of parts to make cars before 2021 started, and booming sales means there simply aren't enough chips to go around at the moment. NXP exited Q3 with just 1.6 months of supply, about 30 days of supply short of the 2.5-month target the company holds itself to. In other words, NXP can't manufacture chips fast enough for its automaker customers.
Now, pair that shortage of supply with fundamental changes to how a vehicle is made -- namely, electric drivetrains, premium infotainment systems, vehicle connectivity, driver assist systems, etc. Let's just take one of those systems: electrification. An electric vehicle drastically reduces the amount of traditional parts in a car. In overly simplistic terms, a battery pack and motor replace a patchwork of systems like an internal combustion engine, cooling system, fuel system, and so on. However, while the need for traditional moving parts is greatly reduced, semiconductors are proliferating in the modern car and truck.
Sievers said a typical hybrid or electric car needs about $900 worth of chips, double the amount of an internal combustion drivetrain. Plus, hybrid and electric vehicles have gone from about 8% of global production in 2019 to roughly 20% this year. And this is before even talking about how driver-assist systems and vehicle autonomy are impacting cars. Get the idea? Supply chains are being racked by incredibly fast changes in how autos are manufactured.
The good news, at least for NXP
Given that half of its revenue comes from the automotive sector, NXP is an interesting proxy for the current parts supply shortage. For now, demand outpacing production means NXP's sales will grow again in Q4 (at an expected rate of 17% to 23% year over year). But extended lead times for orders (in many cases well beyond a year) mean the company could continue to grow in 2022 and beyond. Plus, to keep up with future demand as more vehicle production switches over to hybrid and electric, NXP is investing in new manufacturing capacity with long-term buying commitments from its customers.
It's important to remember chip fabrication is cyclical in nature, as is all manufacturing. At some point, the supply/demand imbalance will normalize, and NXP's growth trajectory will cool off -- or even contract for a time. Nevertheless, given how vitally important semiconductors are becoming to autos, and for NXP's other end markets like industrial equipment and communications infrastructure, this is likely to remain a growth story for the very long term. Just expect some ups and downs along the way.
After the Q3 update, NXP stock trades for 24 times trailing 12-month free cash flow to enterprise value. This currently isn't a cheap semiconductor designer and fab, but it is perhaps a long-term value if you plan to buy and hold throughout the extensive evolution of the auto industry over the next decade and beyond.
