Makers of semiconductors are seeing valuations hit amid a cyclical downturn, but the future long-term growth picture remains intact.
Last year was a tough one for the semiconductor industry – the makers of those essential electrical components found in all modern technology. Fears over slowing demand for memory chips, rising inventory levels and the ongoing US/China trade war led to significant declines in share prices in the second half of the year.
For us though, the bigger picture hasn’t changed. Long-term demand is coming from a raft of digital technologies, broadly referred to as the Fourth Industrial Revolution. The structural growth drivers to these companies therefore remain firmly in place.
Long-term projections are for revenue increases in the double digits in areas like high-performance computing and automotive
One of the main reasons for recent share price declines has been demand weakness, leading to oversupply and inventory build-up. However, discussions on my recent research trip to China showed that companies all along the semiconductor manufacturing chain – including makers of silicon wafers and DRAM (dynamic random-access memory) chips – are taking action to address these. Time and again, we heard the same message: companies are focusing on a more disciplined approach to capital allocation during any potential slowdown – thus putting them on a firmer footing for the future. This is very different to when I first covered the sector over 20 years ago.
There are probably two to three quarters of weakness ahead. However, our view after meeting companies and industry specialists in China is that the issues impacting companies in the semiconductor supply chain – over-ordering, concerns over trade – are cyclical, not structural.
At the same time, the long-term goals for these companies remain unaltered. The largest are focused on understanding the technology requirements of their customers in five to 10 years’ time, not just what’s around the corner.
For that reason, while a slowdown in smartphone growth has impacted short-term demand, long-term projections are for revenue increases in the double digits in areas like high-performance computing and automotive. Higher-specification chips (7 nanometre), are required for innovations such as artificial intelligence and the move towards autonomous vehicles.
It is not all bad news in smartphones either. Even though smartphone shipment growth has slowed, the complexity of the handsets is still increasing, with increasing functionality resulting in higher semiconductor content per device.
Perception vs reality
The bottom line is that, without downplaying the short-term issues facing semiconductor companies in late 2018/early 2019, weaker share price performance can also be attributed to profit-taking from investors, not long-term company fundamentals.
Valuations of these companies are presently attractive as we believe the market is primarily viewing these companies in the short-term. Many companies in the semiconductor chain are focusing on sustainable long-term returns in their businesses, resulting in better supply-side discipline and therefore higher free-cash generation. A number of firms are returning this cash back to shareholders, either through buybacks or higher dividends.
For us, the long-term growth picture remains intact.