It has been a rough year for semiconductor stocks, but all may not be lost. After all, semiconductors power all of today's big technology applications, from artificial intelligence, to the Internet of Things, to the Metaverse and electric vehicles. While somewhat cyclical, semiconductor stocks are usually generally quite profitable, and their stocks are less expensive than the high-flying software sector.
Despite this year's historic slump in PCs, smartphones, and consumer electronics, several top chip stocks have the right products and end-markets to grow through the current downturn, and pay you a rising dividend along the way. Here are five names you don't have to worry about, and can look forward to collecting a rising annual dividend payment year in and year out.
Image source: Getty Images.
The leading edge will still lead the way
First, while overall chip demand may decline in 2023, category leaders will always want their new products to be on the latest and greatest technologies. That's where the two indispensable global companies that enable leading-edge chip production, Taiwan Semiconductor Manufacturing Corporation (TSM -0.34%) and ASML Holdings (ASML -1.03%), should continue to grow through any 2023 downturn. That means investors can probably look forward to another increase for TSMC's 2.4% dividend, as well as a dividend increase for ASML's 1.2% payout.
Although acknowledging the industry headwinds in the first half of 2023, TSMC's management also said on its October conference call, "We expect our business to be supported by stronger demand for our differentiated and leading advanced and specialty technologies, and for 2023 to be a growth year for TSMC."
That TSMC will be able to grow next year is certainly impressive, considering the booming growth it's seen over the past two. Last quarter, TSMC recorded 48% revenue growth and 81.5% operating oncome growth. Given a cyclical sector like semiconductors, growing at all after a year like that would be quite the feat.
However, TSMC's process technology lead over all other foundries, which has only grown in recent years, is helping this industry leader defy the gravity of the business cycle. That important technology lead is probably why Warren Buffett bought into the stock earlier this year.
TSMC itself, of course, is dependent on equipment from ASML, which has a monopoly on extreme ultraviolet lithography (EUV) needed to make chips with transistors 7 or fewer nanometers apart.
TSMC rivals Samsung and Intel (INTC 0.64%) are also racing to catch up, and DRAM memory production is just now beginning to use EUV, whereas logic and foundry chips started using EUV a few years ago. That means demand for EUV is rising, and that growth curve will continue for years. In fact, demand for EUV is outstripping ASML's capacity to supply it, despite the recessionary economic environment.
On its third-quarter conference call, ASML management noted:
I have to say the lion's share of our customers really [keep] on pushing us in terms of getting the tools and getting them sooner rather than later. There [are] a few customers that are indicating a preference for some delay, but the lion's share of the customers are really pushing and they are raising their hands to say if there is a delay someplace else, then please get the tools to us even earlier.
There is a technical reason ASML should also grow next year. Because of shortages, ASML has been shipping tools to customers before final qualifications. ASML can't recognize revenue of a shipped machine until it is qualified at the customer, which takes longer. So ASML's recognized revenue has been lower than its orders this year; for instance, while ASML recorded only 5.8 billion euros in sales last quarter, its order book came in at 8.92 billion euros. However, that revenue will be recognized next year, which bodes well for growth even if the semiconductor market softens further.
Auto and industrial are still booming
The semiconductor sector may seem confusing to many, as some parts of the market are in drastic oversupply, such as memory and GPUs, whereas other headlines point to a huge "chip shortage."
The shortage is mostly on mature node chips that largely fuel automotive and industrial applications. Even if many are downbeat on the auto sector next year, electric vehicles (EVs) and autonomous vehicles require more semiconductor content than internal combustion engine cars do, and EVs and autonomous applications will make up more and more of the car market with each passing year. The same goes for industrial chips that fuel automation, and given the rise in labor costs amid this year's inflation, industrial automation chips will also remain in high demand no matter what the economic environment.
That's why two dividend semiconductor companies, NXP Semiconductors (NXPI 4.18%) and Microchip Technologies (MCHP 5.21%), each with outsize exposure to the auto and industrial sectors, may be in better shape.
NXP gets about 50% of its revenue from auto end markets and another 22% of revenue from Internet of Things (IoT) applications, so it's well situated. On its recent third-quarter conference call, management also noted that more than 70% of its products have lead times over 52 weeks, and that it's already sold out for 2023 in those key auto and industrial markets. That seems to mitigate risk in this chip company in 2023, which yields 2.1% and trades at just 15.7 times trailing earnings.
Meanwhile, peer Microchip is also a large player in auto and IoT chips and is also projecting resilient operating results next year. CEO Steve Sanghi noted that the industrial, automotive, aerospace and defense, data center, and communications infrastructure end markets all remain strong, and those end markets make up 86% of Microchip's sales. This is why Microchip was able to grow over 25% last quarter, and why it still believes it will be supply constrained going into 2022. For the current fourth quarter, management's midpoint of guidance pointed to 22.7% year-over-year growth.
Microchip's solid results are even enabling it to invest in capacity increases next year, despite the possibility of recession. Microchip currently yields 1.8% and trades at just 12.3 times next year's earnings estimates.
Communications infrastructure continues to grow at a solid pace
You may have noticed that Microchip identified not only auto and industrial markets but also communications infrastructure as a solid growth area, despite the macroeconomic headwinds. The buildout of edge communications, as well as the expansion of broadband and 5G infrastructure happening next year, helped along by government subsidies, should enable growth for chips focused on this infrastructure buildout, too.
Enter Broadcom (AVGO 0.61%), which has been one of the more impressive dividend growers over the past five years. Under CEO Hock Tan's acquisition strategy, in which Broadcom buys semiconductor or software companies and efficiently folds them into its corporate umbrella, free cash flow has doubled over the past four years. Even more impressive, Broadcom's 3.3% dividend has surged as incredible 9.5 times over since 2016 – a 38% annualized growth rate.
Image source: Getty Images.
Not only that, but Broadcom's large exposure to infrastructure and networking chips are keeping management's projections strong for next year. When pressed on the company's outlook on its recent conference call, Tan said:
Infrastructure, by looking at it, comes from hyperscale, in building their data centers and components to their data centers; in service providers, like telcos, where we see our strength in broadband access, gateways and broadband. And I know people are finding hard to imagine, we're seeing it even in enterprise, where we do not -- that's why I made a comment earlier, we do not see across a cross-section of large enterprises a reduction in the IT spending for 2023.
Tan noted that even if the economy slows, companies are still investing in IT to make themselves more efficient. Currently, Broadcom is also trying to buy VMware (VMW) in a massive $61 billion deal, which would make the company essentially half software, half semiconductors. But regardless of whether the deal gets approved, Broadcom's history of smart acquisitions, targeting of attractive, recession-resistant markets, and excellent execution should enable further dividend growth even in a down 2023 for the chip sector.
The whole sector has sold off, but these dividend stocks look like bargains
Given the selloff across the semiconductor sector, these stocks have also declined in 2022. Still, the producers of chips exposed to leading-edge, auto and industrial, and communications infrastructure chips appear set for resilient profits through next year. That means their dividend growth should be secure, making their stocks look like bargain-priced gems today.
