2 Semiconductor Stocks Looking Good Despite Challenges

Companies in the Semiconductor – General industry are at the forefront of the ongoing technological revolution based on HPC, AI, electrified and automated driving, IoT and so forth. The semiconductors they produce enable the cloud to function and help analyze the data into actionable insights that can be used by companies to operate more efficiently. The pandemic hastened the ongoing digitization of every aspect of life. But this brought forward several years of investments, weakening the prospects for subsequent quarters. The major end markets for semiconductors (excluding automotive) have been in a state of imbalance between demand and supply, a situation that hasn't completely corrected. With the financial tightening increasing economic uncertainties, it has become notably harder to predict the impact on this industry. This in spite of the fact that supply chains continue to adjust to increase reliability, build some inventory, reduce dependence on China, and onshore projects with national security implications. All these factors are contributing to the uncertainty and as a result, the valuation is also looking rich. According to the latest data from the Semiconductor Industry Association (SIA), global semiconductor sales are expected to decline 10.3% in 2023 followed by a rebound of 11.9% in 2024, as sluggish macroeconomic conditions are exacerbating softness related to the ongoing cyclical downturn. Gartner expects an 11.2% decline in 2023, as the chip surplus continues to hurt pricing while weak end demand in consumer markets spreads to businesses hurt by the economic slowdown. While macro concerns are impacting near-term performance, the long-term outlook continues to favor strong growth due to auto electrification, structural changes in industrial automation, data center strength, and increased adoption of the cloud, AI, IoT, etc. NVIDIA Corporation looks very strong right now, with renewed momentum in its business, although STMicroelectronics is also doing well.

About The Industry

The companies grouped under the Semiconductor – General category produce a broad range of semiconductor devices, both integrated and discrete, like microprocessors, graphics processors, embedded processors, chipsets, motherboards, wireless and wired connectivity products, DLPs and analog, serving multiple end markets. It includes companies like NVIDIA, Texas Instruments, Intel and STMicroelectronics.

Major Themes

The long-term outlook for the industry remains robust because of its being on the building-block side of technology, which makes it crucial for the proliferation of the Internet and the ongoing digitization of every aspect of life. The short-term outlook appears bleak however. The pandemic had accelerated the move toward digitization, but it also created a lot of imbalances in demand and supply. The smartphone market for example (an important application of semiconductors) is seeing issues on both the demand and the supply sides. Demand is affected by inflation while supply was affected by not only inflation but also geo-political tensions, China shutdowns and supply chain constraints. Another major chip consumer is the PC market, where the consumer and education segments remain inventory-laden and therefore, soft following two years of very strong growth. Even enterprise deployment is slowing down because of concerns about economic growth. With global economies engaged in financial tightening, there is the concern that demand will weaken significantly before it picks up again. But even this outlook is uncertain because we don't really know where the interest rate hikes will take the economy.

The good news is that some of the weakness in these traditional markets is being made good by strength in emerging areas like AI and machine learning, IoT, and automotive. ReportLinker expects the AI chip market to grow at a CAGR of 29.9% between 2022 and 2030. Driven by Internet connectivity across the developed and developing worlds and supportive technology such as sensor networks and AI adoption, the IoT market is also expected to grow steadily over the next few years. Future Market Insights expects the market to grow at a 5.3% CAGR between 2022 and 2032. Mordor Intelligence expects a stronger 14.7% CAGR between 2022 and 2027. Automotive electronics is another area of evolving needs with increasing electronics (including ADAS), safety enhancements and transition to electrified power trains being important drivers. Grand View Research estimates a 10.7% CAGR through 2025, which it attributes to awareness regarding energy-efficient lighting systems, as well as increasing sales of luxury vehicles that come fitted with navigation and infotainment systems. Automation and robotics, with increasing adoption across industrial operations, are other areas of growth. These strong end markets will drive continued demand for semiconductor components for years to come.

Semiconductor supply chains are adjusting. Semiconductor supply chains have become increasingly efficient over the years. While this has brought down cost, the just-in-time model has made the supply chains relatively unreliable in case of external disruptions, as happened during the pandemic, or when China imposed its zero tolerance COVID shutdowns. This, along with the other factors, the recently-imposed restraints on dealing with China is leading semiconductor companies to diversify their supply chains and reduce their dependence on China. This is an ongoing process that will take several years. In the meantime, there is a growing concern that all the most important leading-edge chips are currently made in Taiwan, a country that China threatens to annex all the time. Since this has national security implications, there is an ongoing drive to onshore manufacturing. The $52 billion infusion from the CHIPS Act will help.

Zacks Industry Rank Indicates Mixed Prospects

The Zacks Semiconductor-GeneralIndustry is a stock group within the broader Zacks Computer and TechnologySector. It carries a Zacks Industry Rank #86, which places it in the top 34% of the 250 odd Zacks-classified industries.

The group's Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates that near-term prospects are moderate. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of 2 to 1.

An industry's positioning in the top 50% of Zacks-ranked industries is normally because the earnings outlook for the constituent companies in aggregate is relatively strong. The opposite is true for stocks in the bottom 50% of industries. In this case, the aggregate earnings estimate for 2023 is down 31.4% from the year-ago level while the aggregate earnings estimate for 2024 is down 9.3% from last year. Although, April appears to have been a bottom for both years.

Before we present a few stocks that you may want to consider for your portfolio, let's take a look at the industry's recent stock-market performance and valuation picture.

Stock Market Performance is Improving

Tracking the performance of the Zacks Semiconductor – General Industry over the past year shows that the industry has traded at a discount to both the broader Zacks Computer and Technology Sector and the S&P 500 index through December, leveling through the month of January and pulling ahead ever since then.

The industry has gained 51.9% over the past year. The broader technology sector gained 10.6% while the S&P 500 index gained just 3.2%.

One-Year Price Performance

Image Source: Zacks Investment Research

Current Valuation is Rich

On the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at 40.28X, which is a 41.7% premium to its median value of 28.43X over the past year. Additionally, the S&P 500 trades at 18.98X while the sector trades at 24.71X. Therefore, the industry appears overvalued in all respects.

Forward 12 Month Price-to-Earnings (P/E) Ratio

Image Source: Zacks Investment Research

2 Stocks To Consider

Given the many challenges related to demand and supply issues and the significant downward revisions in estimates through a good part of the past year, this is not an industry that can be recommended right now. At the same time, the industry consists of several technology heavyweights that are the backbone of how computing is done these days. Therefore, a closer look at a couple of stocks may be a good idea.

NVIDIA Corporation (NVDA): Santa Clara, California-based NVIDIA Corporation provides graphics, and compute and networking solutions in the U.S., Taiwan, China and other markets. Its graphics processing units (GPUs) are the most popular in the gaming segment. NVIDIA is also at the leading edge of enterprise, data center, cloud and automotive deployments today.

Generative AI is driving exponential growth in compute requirements. Because NVIDIA's accelerated computing is versatile, energy-efficient and has low total cost of ownership, companies are rapidly transitioning to its products to train and deploy AI. This is opening up opportunities and leading to broad-based growth across geographies and markets. The automotive, financial services, healthcare and telecom verticals are particularly strong, as AI and accelerated computing are quickly becoming integral to customers' innovation road maps and competitive positioning. NVIDIA is also seeing momentum across all its segments, which is evident from the strong sequential growth in the last quarter. With inventory corrections in gaming and professional visualization in the rearview mirror, the company is now positioned to benefit from its operating leverage.

The Zacks Consensus Estimate for fiscal 2024 (ending January) is up $2.98 (66.5%) in the last 30 days and up $3.96 (66.2%) for the following year.

The Zacks Rank #1 (Strong Buy) stock is up 104.2% in the past year, with particular acceleration in the share price since January.

Price & Consensus: NVDA

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STMicroelectronics N.V. (STM ): The company designs, develops, manufactures and markets a broad range of semiconductor integrated circuits and discrete devices used in a wide variety of microelectronic applications, including telecommunications systems, computer systems, consumer products, automotive products and industrial automation and control systems.

STMicroelectronics's strength continues to come from the automotive and industrial verticals. In auto, it is coming from structural transformation and inventory replenishment. Management strategy remains focused on electrification, where its SiC MOSFET devices are enabling an increasing number of design wins. Industrial strength is coming from semiconductor pervasion, as also factory automation, robotics and building control. Here too, STM is seeing considerable momentum. Backlog continued to normalize in the last quarter, although it is still above the company's capacity to sell in some technologies and packages of auto and industrial markets.

STM beat the Zacks Consensus Estimate by 13.4% in the last quarter. In the last 60 days, the current year EPS estimate of this Zacks Rank #3 stock increased 20 cents (4.9%). The 2024 estimate dropped 23 cents (5.5%).

The shares of the company have appreciated 12.9% over the past year.

Price & Consensus: STM

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