Technology, Media & Telecom

Ahead of the Curve ™

AI Infused Growth To Overcome Cyclical Concerns

Feb 21 2019

Report by Matthew D. Ramsay, Joshual Buchalter, CFA and Ethan Potasnick

We believe Application-Specific Computing and Artificial Intelligence (AI) will combine to infuse growth in 4 key markets (Datacenter, IoT/Industrial, Automotive, & Gaming/VR) to the tune of ~8.7% CAGR through 2023, keeping our semiconductor growth estimate strong (~5% CAGR) despite PC/smartphone stagnation and the recent trade-influenced cyclicality.

Focused On AI-Infused Growth Markets: Datacenter, IoT/Industrial, Auto, & Gaming/VR
After a period of ~26 months from Jan. 2016 to Mar 2018 that saw the SOXX grow >2x, 2H18 saw the sector’s most recent downturn. Since the June 2018 peak, the SOXX is down ~6% (and was down ~26.5% peak-to-trough on 12/24/18) as investors have been forced to reconcile global trade fears, macro uncertainty, and a slowing of M&A. While we would not rule out another small round of estimate cuts in April and we certainly are NOT claiming semiconductor stocks are void of cyclicality, median and average forward P/E for the group sits at ~13x, roughly 4 turns below levels less than six months ago. We believe current levels favor stock selectivity in light of the uncertain macro, but broadly present an attractive entry point for many stocks trading below recent historical valuations. Further, while the near-term reset has reminded us demand is certainly not impervious to painful short-term shocks nor softening in the Chinese economy, we reject the notion that the cyclicality of old has returned that was ripe with irrational pricing and industry over-supply. In fact, even in the worst month so far of the current correction, in Dec, where ex-memory industry revenue declined Y/Y and memory pricing corrected sharply, industry revenues were still 20% above Dec of 2015 with memory industry revenues up 89%!

Additionally, as we refer to in this report as the “Old Guard”, several of the largest semiconductor end markets in terms of volumes/revenue (est 55% of 2018 spending in total) are nearing ex-growth in aggregate (Mobile Devices & Infra-structure, PCs, Wired Communications, and Consumer Electronics estimated 0.9% CAGR through 2023), leaving AI-infused growth markets of Datacenter, IoT/Industrial, Auto, and Gaming/VR to drive the vast majority of market growth over the next decade at a clip of ~8.7% CAGR in aggregate. Therefore, we suggest investors focus on differentiated semiconductor suppliers (and stocks) leveraged to these AI-infused markets. This focus should serve as a primary investment criteria in semiconductors, as it has in our stock ratings. In this report, we update our AI-Driven investment framework and add detail on the automotive market in connection with new stock launches focused on that exciting vertical.

Initiate Outperform: IFX.GR, LSCC, ON, STM
Downgrade: AVGO From Outperform To Market Perform
Initiate Market Perform: MCHP, MXIM
Current Market Perform: CRUS, INTC, XLNX & Now AVGO

Hot Investor Debate Points In Semis For 2019 … And Our Top Picks: AMD, MPWR, IFX.GR

1. When Is The Bottom? Since last October, the semiconductor markets have felt softer demand, particularly in China, exacerbated by US/China trade/politics. Many companies, including Microchip/NXP/STMicro in MCUs/analog and Intel/AMD/NVIDIA in CPU/GPUs, have indicated 2H19 should see a strong rebound. While we would not rule out another set of mild estimate cuts during April and the 2019 pre-5G smartphone market is likely to remain soft, we believe in the long-term secular drivers in the semiconductor market and reject the idea that old cyclicality has returned.

2. The Moore’s Law Asymptote And TSMC Catching Intel (+AMD, -INTC): The multiple delays of 10nm silicon at Intel open opportunities for Xilinx, NVIDIA and AMD to gain dollar share of key markets with near-equivalent silicon from TSMC’s 7nm process. These vendors should be on silicon parity with Intel for the first time in a decade during the 2H of 2019, and we believe share gains could result for AMD and increased capital investment on 7nm could coincide with margin pressure of the 10nm ramp at Intel.

3. Programmable Analog Is Exciting (MPWR): Rather than running a catalog business at scale, we believe more programmable analog component design can yield above-sector growth sustainably in automotive, datacenter and industrial IoT markets. This applies to Outperform-rated Monolithic Power and Silicon Labs which should benefit. Hefty valuations for both we believe are deserved. We believe many investors have been waiting for a pullback in MPWR shares and a more conservative near-term outlook; here is the chance.

4. How To Be Best Positioned Ahead Of The Growth Of Electric & Intelligent Cars (IFX.GR): Versus an ADAS sense/react architecture, we believe autonomous drive computing will emerge as an incremental ~$3B TAM by 2023 with >$2K per vehicle in compute content, which should drive strong growth for NVIDIA, Intel, Ambarella and other digital auto semis vendors. While that trend gets significant investor attention, we believe the move from <5% currently to 50% electric vehicle penetration globally by 2030E will handsomely reward those investing in broad-based auto and power semis infrastructure today, including Outperform-rated STMicroelectronics, NXP Semiconductor and our Top Pick Infineon.

Key Conclusions From This Report
1. While Semiconductors Remain Tied To Shorter-Term Demand Cycles, We Believe Long-Term Secular Drivers Are Stronger And Less Consumer Driven: We update our proprietary semiconductor investment framework focused on the AI-driven growth markets of Datacenter, Automotive, Industrial/IoT, and Gaming/VR. In aggregate, we estimate these markets will grow near 10% going forward and provide a robust and durable platform for overall semiconductor market growth versus the “Old Guard” markets that we believe are roughly flat going forward in aggregate. Further, this growth should be less cyclical and also less exposed to consumer markets. In this report, we provide an analysis of exposure to each of the AI-driven growth markets and more stagnant “Old Guard” markets for our entire universe and we suggest long-term investors use this as a primary contributor to their investment process as we have done in our stock ratings.

2. Automotive Semis Driven By Two Parallel And Complementary Vectors – Electrification and Intelligence/Autonomy – We Quantify Growth From Each:We forecast 2018-23E automotive semiconductor growth of 8.5% from $39B to $59B driven almost exclusively by content growth (not units) from the combination of these two vectors – and we quantify the growth coming from drivertrain/power/electrification (~$6.2B of growth) and from ADAS/autonomous computing/sensing (~$2.9B of growth) versus other peripherals. While the push to ADAS/autonomous features receives significantly more attention, we believe the push toward electrification has clearer regulatory tailwinds. Cowen forecasts EVs will be 30% of vehicle production by 2025 (a 30%+ 7-year CAGR) and close to 50% by 2030.

3. Automotive Exposure Is “Good”, But Not All Automotive Exposure Is Created Equal: We present a proprietary analysis of automotive revenue exposure for our coverage universe overall (and their growth rates) and across different automotive silicon components (Figures 16, 17). Outperform-rated NXP Semiconductor has the largest automotive business ($4.5B) and highest overall exposure (48% of revenue), but a slower growth rate ~3% 2016-20E CAGR (though forward guidance is for 7-9% growth). Outperform-rated Monolithic Power (MPWR) and Intel’s Mobileye (INTC) have the highest growth rates off of smaller bases (47% and 66%, respectively). Our top pick Infineon (IFX.GR) we believe hits the sweet spot – holding the 2nd-largest franchise (€3.4B or $3.8B), 43% automotive revenue exposure, leverage to the fastest growth vector (ICE->EV) and the largest automotive USD growth of the group – even before EVs ramp penetration in earnest. While Outperform-rated ON Semiconductor (ON) and STMicro (STM) are less directly exposed to the growth vectors above, they have sizable automotive exposure and we view their valuations as compelling as they invest to expand their automotive/industrial footprints.