The cornerstone of all our beloved technology gadgets is the humble semiconductor chip. These tiny circuits are able to fit an enormous amount of computational power into increasingly compact designs thanks to Moore’s law. Semiconductors are indispensable components in our daily lives, whether we're using cell phones, personal computers or automobiles.
In 2020, the world witnessed a global semiconductor shortage as a sudden spike in demand met with unprecedented supply chain challenges resulting from the pandemic. Although the shortage eventually turned into a glut as supply chains righted, the semiconductor industry is still projected to grow at a compound annual growth rate (CAGR) of 12.2%, reaching a worth of $1.38 trillion by 2029 according to estimates from Fortune Insights. The expansion of IoT (Internet of Things) devices and wearable technology, such as artificial reality headsets, is also anticipated to propel the industry to the status of a trillion-dollar market, according to McKinsey.
In this article, we will delve into two of my favorite undervalued semiconductor stocks which are well-positioned to benefit from the industry's sustained growth trend; let's dive in.
1. Intel
Intel (INTC, Financial) is a market leader in the CPU industry and dominated the market for decades. However, over the past couple of decades, the company has fallen from grace due to a variety of manufacturing issues and intense competition. Then, Intel fell behind with its production of its 7 nanometer chip in 2021. This gave competitors such as Taiwan Semiconductor Manufacturing (TSM) the opportunity to overtake Intel and even produce smaller 5nm and 3nm chips. Intel even had to outsource a portion of its manufacturing to Taiwan Semiconductor, which was a major blow to the company.
The good news for Intel is that it is still the market leader in the PC CPU and Server market with ~71% market share, according to CounterPoint Research. Apple (AAPL) has begun to create its own silicon with its M1 and M2 chips, but the majority of other OEMs still use Intel's CPUs.
In addition, Intel is poised to benefit from the $50 billion CHIPS Act, which aims to boost the manufacturing of semiconductors in the U.S. Intel is expected to receive a staggering $20 billion from the CHIPS Act and between $5 billion and $10 billion from the FABS Act. The price of this assistance is that it will have to re-enter the fab market (i.e. producing semiconductors for other companies), which it had previously abandoned to more cost-efficient competitors like Taiwan Semiconductor.
Breaking this down, Intel aims to get a staggering $3 billion per fab built in the U.S., which is a lot. These subsidies are so generous that chip designers such as Nvidia (NVDA, Financial), Advanced Micro Devices (AMD, Financial) and Qualcomm (QCOM, Financial) have been reported to potentially be opposing the CHIPS Act, but favouring the FABS act, which includes design credits.
Financial headwinds
Intel reported tough financial results for the fourth quarter of 2022. Its revenue was $14.04 billion, which plummeted by 31% year over year as the semiconductor industry is going through a cyclical downturn.
Breaking down revenue by segment, its Client Computing Group felt the brunt of the decline as the consumer PC market experienced low demand. A positive is its Network and Edge business and Data Center and AI reported results which were aligned with analyst forecasts.
Another positive for Intel is its CEO Pat Gelsinger (who joined in 2021) seems to have the perfect balance between realism and optimism. In the Q4 earnings call, he was honest about Intel's lost market share but said he believes “stabilization” is coming in 2023.
He also has the respect of the company's workforce, given he originally joined the company at 18 years old back in the 1970s, and thus his return is symbolic and he knows the company well, despite the challenge being vast.
Intel also has product tailwinds as the company launched its Sapphire Rapids Xeon CPU in January 2023. This release signaled Intel has found its bearings. A test by wctech indicated this new Intel processor had a 44% larger performance gain relative to competitor AMD’s EPYC, which had a gain of 21% for AVX-512 workloads. This is a positive sign and shows Intel is still in the game despite the stiff competition from AMD.
There is a buzz around the cloud industry for Intel’s Sapphire CPUs, which have been praised by the major hyperscalers such as Amazon (AMZN, Financial) and Microsoft (MSFT, Financial). Intel reported it has major plans to ship over 1 million units by the end of the second quarter of 2023, which is a positive sign.
Despite the momentum, Intel still has a long way to go for a full recovery with its operating income down 70% year over year at $2.3 billion.
The company does have a solid balance sheet with $28.3 billion in cash and marketable securities versus debt of $42 million.
Valuation
Intel trades at a price-earnings ratio of 15, which is cheaper than the IT industry average of 24 and slightly cheaper than its own five-year average.
The GF Value chart indicates a fair value of $43.77 per share and thus the stock is “modestly undervalued” at the time of writing.
2. Micron Technology
Micron Technology (MU, Financial) is the fourth largest semiconductor manufacturer in the world, and one of the top three suppliers of DRAM components.
DRAM, or Dynamic Random Access Memory, is a vital component of all computer systems. If you have ever upgraded your laptop RAM, you may have seen the brand name “Crucial,” which is a Micron brand. Micron makes ~74% of its revenue from DRAM, which is a specialist product in itself. Fewer and fewer companies have been making DRAM as the market has consolidated; for example, Intel previously sold off its DRAM business years ago.
Micron is poised to benefit from the forecasted growth in the artificial intelligence (AI) industry, which is expected to reach a value of ~$1.6 billion by 2030, according to Precedence Research. According to the CEO of Micron, AI servers can use up to eight times more DRAM than a traditional server. Therefore, Micron has a huge runway for growth as the AI industry grows.
Micron makes also makes ~24% of its revenue from NAND, or Flash Memory. NAND is expected to be used up to three times more in AI servers. Flash memory is also a specialist industry that has consolidated over time. Intel sold its NAND business to Micron competitor SK Hynix (XKRX:000660, Financial) for ~$7 billion in 2021, with the first phase of the acquisition complete by the start of 2022.
Recovering financials
Similar to Intel, Micron has also faced the brunt of the cyclical decline in the semiconductor industry. The company reported revenue of $3.69 billion for its second quarter of fiscal 2023, which plunged by ~53% year over year.
A positive is the company’s mobile business has started to recover, with revenue increasing by 44% quarter over quarter to $945 million.
According to the earnings call, management expects a volume boost in DRAM and NAND shipments throughout the latter half of 2023, as supply/demand dynamics start to adjust. There is currently a lack of industry demand (and oversupply), which means Average Selling Prices (ASPs) are down substantially.
The good news is Micron’s management has acted fast by slashing its capital expenses for the full year of 2023 by 40% to $7 billion.
The company has also reduced its operating expenses from $996 million in the first quarter to $916 million in the second quarter as it aims to get a handle on its expenses.
Micron’s balance sheet is also in a strong position to weather any storm with $12.1 billion in cash and short-term investments compared to $12.3 billion in total debt.
Valuation
Micron trades at a price-earnings ratio of 10.5, which is approximately 23% cheaper than its five-year average. The stock is also cheaper than many other stocks in the semiconductor industry.
The GF Value chart indicates a fair value of $58.87 per share and thus the stock is “fairly valued” at the time of writing.
Final thoughts
Both Intel and Micron are two leading semiconductor chip manufacturers which are facing a series of headwinds. Intel is still the CPU industry leader by market share, which is a positive sign, although its manufacturing is lagging behind. Therefore, the company faces challenges on the competition front. On the other hand, I believe the issues Micron faces are mostly from the industry cyclicality and this I think it is a safer bet for the long term.
