I’ve been looking through a number of these companies in the semiconductor industry, a few of them offer pretty high and even growing net margins, lots of FCF and a solid 4%+ dividend. The ones I found of interest were TSM, MCHP, and SPIL. Are there deteriorating fundamentals in the industry, or new tech/competitors that are the cause of these seemingly low valuations? I’m not really knowledgeable about the industry, just looking to learn more.
I don’t follow this industry that closely, but in general terms there are two types of semi companies – fabricators, and fabless. Fabricators actually make the chips, which is typically a capital intensive, low margin, commodity business (a chip is a chip) – you wouldn’t exactly call this a “good” business model, although the companies with the most efficient operations (low cost producers based on scale and up to date equipment) can make a buck in a decent environment. The stocks generally trade around expected semi demand (consumer eletronics) and chip pricing – there’s some fairly sophisticated forecasting that goes into this to try to predict stock prices and as a generalist it is fairly difficult to compete with the industry specialists forecasting this stuff on a weekly basis (or whatever – I forget how often the data comes out). Often, the stocks will trade on perceived directional changes in prices and demand prior to the release of the data. Fabless companies just design the chips, which involves limited capex obviously – it’s basically an engineering & design shop. I find these difficult to invest in since its inherently a design in business model, where new chips must constantly be created and designed into products in order to generate revenues and profits. When it works, it often really works, and it’s not unusual to see operating margins as high as 40-50% for an asset light business (sweet). On the other hand, it’s difficult to determine which chips are going to work, and which products the chips go into are going to succeed in the market place. You can have long dry patches with some of these companies where no successful chips are currently in production, and the company is basically sitting on a lot of cash (hopefully, at least), perhaps burning through some of it slowly. It’s a feast and famine model, in other words, and you either need to have a really technical background or have your finger right on the pulse of the industry to have a good sense of which companies will succeed, which is hard to do (otherwise you are just chasing the trend and relying on management comments, which is pretty risky). So low valuations could be because of weak expectations for the industry, because these are not the greatest businesses, or because fabless companies are in a famine mode with low expecations. New tech is unlikely to be a reason for low valuations among fabricators since they are just manufacturers and roll with the punches vis-a-vis any new tech updates (and nothing is going to replace chips any time soon). Not sure about the specific tickers you listed since I haven’t looked at any of those in a long time.
I cover this industry as a buy side analyst. Bromin did a very good job is describing the basics of this industry, especially pertaining to the larger cap semi like TSM + TXN. For the smaller semi’s, its less about macro factors and more about getting design wins in certain product cycles and riding the coat tail of it. This industry is pretty much view as a trade as you buy on news on a certain company winning a design win or you buy a basket of semi’s based on a early economic recovery. As to why most of the them are dirt cheap, big overhand on this industry is fear of a supply chain inventory correction (started to see signs like PC lead time coming down, couple of bellweathers guiding down like INTC). I would pay close attention this earning season as you will get a lot of datapoints from these semi companies on where this industry is heading