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Semiconductors: the booming chip industry

The semiconductors industry is red hot and chip manufacturers are responding with waves of new investments. Where can investors find attractive opportunities?

Semiconductors are essential to power modern technologies from electronic devices, the Internet of Things (IOT), artificial intelligence (AI), machine learning, to electric vehicles (EVs). Some companies are focused on designing cutting-edge technologies, whereas some are focused on manufacturing the chips, mostly in Asia.

Robust demand 

Demand is extremely strong, boosted by the need for advanced chips to power smart technologies. It is reported that the semiconductor industry is expected to see sales grow by 8.8% and reach USD600 billion in 2022. The demand has accelerated due to high-growth areas such as cloud computing, EVs, IOT, crypto mining, and e-sports.

 

Semis by application-1

 

Moreover, semiconductors demand typically goes through boom-and-bust cycles, but the cycle has become smoother in recent years, supported by the emergence of new industries including EVs, data storage, and smart devices.

 

Semi industry growth

Growth is expected to remain strong for years. On top of technological advances, consumer spending is strong, buoyed by resilient global growth.

Supply playing catch-up

Perhaps, the supply side is the most interesting. The current chip shortage is causing shockwaves, and affecting companies from car manufacturers to game makers, such as for the Nintendo consoles. The pandemic caused factory shutdowns, delivery delays, and shipping issues. The lack of visibility for demand due to pandemic shocks has caused chip makers to under-invest in facilities, as demand boomed beyond expectations.

The outlook is for the chip shortage to get worse before it gets better as chip manufacturers are facing difficulties scaling up supply quickly enough to match the high demand. Supply-chain disruptions are causing delays as high as nine months for autos and three months for consumer electronics. We expect these disruptions to ease by the middle of 2022, with supply for chips improving by year end, and more significant progresses likely in 2023.

Manufacturers appear to be spending massively to scale production, supported by governments that see it crucial to develop domestic chips capabilities. TSMC, which accounts for more than 90% of the advanced processors market, has announced it will spend more than USD40 billion this year alone, to scale up manufacturing. Intel is planning on spending USD25 billion this year and Samsung Electronics is on a multiyear spending spree totalling more than USD100 billion. Intel is also planning to build a USD17 billion factory in Texas by 2024.

The boom in supply is well under way, accelerated by subsidies, by many governments including Taiwan, Japan, US, China, India, and the UK. It has turned into a technological race, as nations cannot afford to be so heavily dependent on others for key components. For example, the US has blacklisted some Chinese companies on national security grounds, making it difficult for them to source key components. More than that, while China has made it clear that technological advancement is one of its key long-term objectives, the US is catching up quickly, providing government support to craft a technological advantage. In the latest twist, the ‘China Bill’, if approved, should channel USD52 billion towards domestic semiconductor manufacturing in the US. The list is long, but Japan is offering USD6.8 billion in incentives to attract global chipmakers and India is budgeting USD10 billion over six years to develop its own semiconductor industry.

Supply will likely take years to catch up with demand. However, due to the massive investments underway, with much more capital entering the market, there likely could be pricing pressure down the road and we can expect competition to intensify.

How to invest?

The chip giants are divided amongst the designers, which develop the cutting-edge technologies, such as Nvidia and AMD and the vendors and manufacturers, with TSMC, Intel, and Samsung Electronics being the largest.

The MVIS US Listed Semiconductors 25 Index, below, tracks the performance of the 25 largest US listed semiconductor companies.

 

MVIS index

Exposure to chips through high growth companies such as Nvidia could be attractive for the long term, but the high valuations make the stock vulnerable to pullbacks. A more diversified approach through an ETF should prove less volatile.

We view the theme as possibly complementary to a broader tech exposure. Looking at the past performance of the tech-heavy Nasdaq 100 Index versus the VanEck Vectors Semiconductor ETF (SMH) suggests that investor sentiment might have become ‘too hot’ recently, and that the medium term could see a return to the mean to follow the Nasdaq. Similarly, the Nasdaq may catch up to semiconductors, supported by favourable valuations of large components such as Meta and Alphabet, while semis could face more resistance due recent multiple expansion.

SMH perf updated 19.01.2022

In other words, investors should be cautious with valuations as the market is particularly sensitive to rising borrowing costs, and semis stocks may face compressions in valuation multiples should global economic growth slow.

Conclusion

Semiconductors is an attractive long-term theme with several growth opportunities. However, investors should be nimble as semiconductors stocks are ‘hot’ recently. They are also vulnerable to a deterioration in economic conditions (although this is not our base case), and waves of corporate investments are likely to intensify competition in the coming years.

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