The market has pulled back amid concerns over rising inflation and the Federal Reserve's aggressive interest-rate increases. One recent casualty has been semiconductor stocks, which many investors consider to be cyclical plays on the economy.
A few analysts have recently downgraded chip names after channel checks reported signs of potential slowing in PC and smartphone sales globally. "We don't have a smoking gun pointing to a correction underway in any of these markets, but it's very clear to us that all 3 segments (gaming, PC and 'broad-based/XLNX') are running at elevated levels," said Barclays analyst Blayne Curtis in a recent downgrade of Advanced Micro Devices.
Amid the pessimism as we exit COVID, the iShares Semiconductor ETF (SOXX 6.54%) is down more than 22% on the year.
But what if investors and analysts are wrong, and this is a tremendous buying opportunity in chips?
With this much apprehension, one would think some weakness would be showing up in this season's earnings reports. Yet when the world's largest foundry, Taiwan Semiconductor Manufacturing (TSM 2.24%), reported earnings last week, it absolutely trounced estimates, while also raising guidance for the year. So at least Taiwan Semi, the largest semi manufacturer in the world, doesn't see much of a slowdown. And that bodes well for the industry.
Blowout results and guidance
In the first quarter, TSM grew revenue a red-hot 35.5%. And even though inflation is a concern on the cost side, TSM's margin expanded, with earnings per share up an even higher 45.1%. Not only that, but management also said TSM would also beat its former guidance of mid- to high 20% growth for all of 2022. Meanwhile, the company announced no changes to its massive capital investment plans of $40 billion to $44 billion this year.
That certainly doesn't seem like there's any type of slowdown in the offing. But with so much concern over elevated buying last year leading to an inevitable bust, how could it be true?
Focus on the megatrend, not noise in units sold
While it's always dangerous for investors to say "it's different this time," the world's largest foundry is telling investors just that, calling the digitization of the economy a "megatrend."
But how can this be true if PCs and smartphone sales are slowing? Because each PC, 5G-enabled smartphone, and artificial intelligence (AI)-focused server will have much more semiconductor content per unit than in the past.
Consulting firm McKinsey estimates that because AI needs so much brute-force computing horsepower, semiconductors will take 40%-50% of total AI revenue, which will grow to 20% of all technology spending by 2025. That compares with 10%-20% in previous technology revolutions, such as the introduction of the smartphone.
On the conference call, TSM management specifically pointed out that its high-performance computing (HPC) segment, encompassing leading-edge processing for data centers both in the cloud and at the edge, surpassed mobile to become the company's largest segment.
[W]hile the momentum in certain end market segment may slow down or adjust in terms of device units, other end market segment remains strong. In fact, we expect our HPC platform to be TSMC's strongest growing platform in 2022 and the largest contributor to our growth, fueled by the structural megatrend driving increasing need for greater computation power and energy-efficient computing. But then more importantly, the increasing silicon content in end devices such as 5G smartphones, PCs, servers, networking, and automotive applications are a much more important factor in supporting our strong semiconductor demand.
AI is becoming a competitive advantage for many companies, and it doesn't appear demand for big data processing both across cloud, the edge, and industrial applications is slowing anytime soon. And with higher-content 5G phones replacing 4G phones, mobile units don't matter as much these days to TSM.
Besides AI in the cloud, automobiles will also see their own revolution. Battery-powered electric vehicles will have as much as 2.3 times the semiconductor content as an internal combustion engine, and fully autonomous electric vehicles could have as much as 10 times the semiconductor content, according to consulting firm KPMG.
In that light, who cares if units come in a few percentage points higher or lower than expected?
Semis look like a good opportunity
The current environment reminds me of late 2018, when rising interest rates and the onset of the U.S.-China trade war caused a market downturn and semiconductor and semiconductor equipment stocks to sell off even harder. That's because many investors still view the sector as highly cyclical.
That turned out to be a pretty good buying opportunity, as the semiconductor index went on to more than double the total returns of the S&P 500 since the beginning of 2019 -- even after this huge recent pullback.
Given the aforementioned megatrends, I think semiconductor stocks should really be thought of more as growth stocks, with perhaps a little more uneven growth than software. But given that semi stocks are largely much cheaper than the rest of the technology sector, today's semi market swoon seems like a golden long-term opportunity.