The recent volatility of semiconductor stocks is largely a result of the historical cyclical nature of the industry.
In our view, the volatility of the semi-automated production cycle should be narrowed because the industry structure is more reasonable and standardized.
We believe that long-term positive factors for the Internet of Things, cloud computing and artificial intelligence should also curb industry volatility, and cyclical weakness can be seen as a potential buying opportunity.
The slump in semiconductor stocks last fall – and the recovery that followed this year – reminds us of the cyclical nature of the industry and the long-term positive factors we believe will bring revenue growth to investors in the coming years. Although the weakness of the semiconductor industry at the end of 2018 is in line with the weak overall economic data, we believe that this recession is a cyclical fluctuation that is unique to the industry, not a sign of further economic slowdown. Fortunately, for investors, these fluctuations may not be so anxious. With the powerful long-term driving force of Internet of Things (IoT), server-dependent cloud computing, and artificial intelligence (AI) that drives chip demand, we believe that although the magnitude of the semiconductor cycle will not disappear, it should be narrowed.
As early as mid-2018, we saw that the semiconductor industry is brewing challenges. As a major buyer of industrial semiconductor products, the Chinese economy is slowing down. The downturn in the memory chip market has also played a role, because in this largely commoditized market, over-purchasing by consumers in early 2018 led to an overstock of these companies, which have just been absorbed.
Table 1: Production and price of semiconductors and other electronic components
The “feast-famine” nature of the 2018 product cycle is a feature of the industry. Historically, the duration of this cycle has been quite short, only four to five quarters. As shown in Table 1, this is the third semi-industry decline during the current economic recovery, and it is also the most obvious decline from the peak to the bottom.
Many of the key factors that initially drove down the share price of semiconductors are now largely reflected in stock prices, some of which have improved. For example, China’s economic situation seems to have stabilized, while the situation in the United States has improved, and the US-China trade negotiations are continuing, albeit intermittently. Industry fundamentals have also had an impact, as buyers’ excess stocks appear to be gradually decreasing in the coming months after last year’s buying boom.
The valuation reached the lower price we believe and played a role in the recovery. As shown in Table 2, at the beginning of December, the expected price-to-earnings ratio of semiconductor stocks fell slightly to 11 times, 25% lower than the long-term average.
Table 2: Standard P/C 500 semiconductor industry index forward P/E ratio
The pessimism of investors is also evident in the steady decline in general earnings expectations of semiconductor listed companies. Although the downgrade of the earnings rating is a natural response to the down cycle, we believe that the downward adjustment has reached a level that ignores the fundamental positive factors. This year's share price rebound may be partly due to investors buying on dips, but it may also be that they acknowledge that the industry landscape is evolving.
At the right time, the right place
We believe that there were two reasons for the overreaction of the market to the semiconductor market challenge last fall. First of all, this is not the highly dispersed and disordered semiconductor industry of the past. Recent integration has led to rationalization of production, and experienced management teams are now better able to achieve a soft landing (balanced supply and demand) when the business cycle bottoms out. In fact, we believe that without this increasingly flexible industry structure, the turmoil last year may be even more dramatic.
Second, the Internet of Things, cloud computing and artificial intelligence – all of which require a large number of chips, convinced us that although the industry may experience cyclicality, these strong long-term positive factors as overall unit and revenue data rises The amplitude of the period should be suppressed.
Explain this is the relationship between semi-automated systems and cars. The recent weakness in Chinese auto sales has weighed on chip demand. But the long-term theme of smart, electric and semi-automatic cars cannot be ignored. We believe that in the next 5 to 10 years, the chip content of a car will rise from $375 to more than $1,000. Therefore, even if the economy brakes on the brakes, the sales volume of the car will decline, and the increase in unit sales should keep the demand for semiconductors stable. Importantly, we see this phenomenon being replicated in factories, homes, and a range of potential smart and connected devices.