As demand softens across several of its end markets and customers take inventory rebalancing actions, the Analog/Mixed Signal Semiconductor industry has entered a slower phase. Most analysts expect this weakness to be short-lived, while agreeing that the outlook for 2024 remains cloudy. Growth prospects over the next 5-10 years, however, are excellent, because of the adoption of new technologies like AI-ML, EVs, smart cities, IoT, etc.
 
Therefore, in the near term, we should expect increased caution at customers, who could order closer to consumption, thus reducing visibility. But this should not be a deterrent considering that there are segments of the market that remain amazingly resilient. While we wait for a suitable entry point, there are a few stocks that could be worth keeping an eye on.
 
These would be stocks like NXP Semiconductors and Magnachip Semiconductor.

About the Industry

The electronic gadgets we use to accurately read our commands, and record, store, retrieve and process the information we throw at them run on semiconductor technology, whether analog (enabling the recording and measurement of real-world information), digital (processing information available in machine-readable language) or mixed signal (enabling conversion of analog signals to digital or digital to analog among other things). Most electronic gadgets use a combination of these components, whether in consumer, industrial, auto, medical, communications, or IoT and other markets.

The industry is cyclical and prices are elastic. Players usually serve multiple markets that offset their individual seasonality, or focus on certain core markets for which they have highly differentiated technology and relationships.

Major Themes Driving the Industry

• There are issues across a number of end markets, which will continue to affect analog and mixed signal chip demand over the next few months. PCs have been weak for a while now (Gartner expects return to growth in Q4; IDC says not so fast, citing uncertain consumer market refresh cycle, businesses pushing device purchases forward, education budgets not rebounding in many markets and the possibility of commercial refresh stretching out to 2025 when Windows 10 support ends). Smartphones are not much better (weak consumer spending stemming from a difficult macro environment, adverse geopolitics and a greater propensity to consume things like leisure and travel offset strong offerings from Huawei and Apple. Inventory builds remain cautious). The industrial market has held up much better, but is currently seeing some softness as customers adjust their inventories. Other markets like automotive, communications (especially 5G), IoT, cloud and AI are better off. Technological innovation in the form of the metaverse, digital health, EVs and other innovative transportation and sustainability considerations are secular drivers. Uncertainties related to dealing with China remain. As a result, the World Semiconductor Trade Statistics (WSTS), which supplies data to the Semiconductor Industry Association (SIA), lowered its 2023 forecast for the global semiconductor market from a 4.1% decline to a 10.3% decline in June.

• The industry is likely to see continued operating challenges. SEMI expects inventory reduction at customers to continue through the end of the current year, which is expected to lead semiconductor manufacturers to cut production, thus lowering utilization rates. At the same time, new fab construction, often supported by government initiatives and their equipping remains in full swing, which brings additional capacity online. This does not look good for pricing. The memory markets have been hit this year as a result of their dependence on the consumer segment, with big players like K Hynix, Samsung Electronics, and Micron Technology announcing production cuts. The good news is that DRAM and NAND markets are bottoming and TrendForce estimates that demand will continue to outpace supply this year and in the next. This should support pricing strength next year. Supply chain issues remain a wildcard, however.

• An emerging issue that semiconductor players are particularly exposed to is geopolitical tensions. The semiconductor supply chain is globally distributed, which means that international relations need to be maintained to ensure that work continues without disruption. While the Russia-Ukraine war didn’t have much of an impact, the souring of relations between the U.S. and China is another story. If China really tries to take control of Taiwan, as many experts expect it will, this could spark a war that would be highly disruptive to the global economy and especially the chip sector. That’s because a leading share of advanced node chips are made on the island of Taiwan. Another geopolitical concern is the increasing awareness among all leading nations of the increasingly larger role that semiconductors are playing in AI-driven electronic weaponry and surveillance mechanisms. As the importance of semiconductors in defense grows, the need to onshore or near-shore production is being felt. This is leading to rebalancing of the semiconductor supply chain not from a cost-reduction perspective but with a far more strategic objective. So the government is trying to incentivize companies to build in the U.S. version of TSM, the main supplier to the U.S. is setting up in the country but the plan is to have this on a much larger scale. The CHIPS Act may help a difficult situation where increased capacity would depress prices while U.S. production would increase costs. In the meantime, the U.S. has ordered restrictions on trading with China, which is also a near-term headwind for players.

Zacks Industry Rank Indicates Weakness

The Zacks Semiconductor – Analog and Mixed industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #196, which places it in the bottom 22% 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 weak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of Zacks-ranked industries is based on the earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions over the past year, we see that analyst opinion about the outlook for both 2023 and 2024 has materially deteriorated since July. Overall, the 2023 estimates have dropped 0.7% over the past year, while the 2024 estimates have dropped 17.3%.

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.

Lagging Stock Market Performance

The Semiconductor – Analog and Mixed industry currently trades at a discount to both the broader Zacks Computer and Technology sector and the S&P 500. However, it has moved around quite a bit over the past year. All three were more or less in line until January, at which time the industry pulled ahead. However, it dipped again in April, while the sector pulled significantly ahead.

Overall, the industry gained 4.9% over the past year while the broader sector gained 33.4% and the S&P 500 12.2%.

One-Year Price Performance

Image Source: Zacks Investment Research

Industry's Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, the industry is trading at a 18.28X multiple, which is a discount to both the S&P 500’s 18.74X and the broader computer and technology sector’s 24.03X. At the current level, it is, however, trading at a slight premium to its median level of 17.62X over the past year.

The industry has traded between the 13.62X and 19.88X multiples over the past year.

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

Image Source: Zacks Investment Research

2 Stocks to Hold for the Long-Term

NXP Semiconductors N.V. (NXPI Quick QuoteNXPI - Free Report) : Headquartered in Eindhoven, the Netherlands, NXP offers semiconductor products like microcontrollers, application processors, communication processors, wireless connectivity solutions, analog and interface devices, radio frequency power amplifiers, security controllers, as well as a range of semiconductor-based environmental and inertial sensors for automotive, industrial, IoT, mobile and communication infrastructure applications. Products are sold to OEMs, contract manufacturers and distributors in China, the Netherlands, the U.S., Singapore, Germany, Japan, South Korea and Taiwan.

NXP announced a positive surprise of 3.4% at the last quarterly earnings announcement. However, while its 2023 estimate rose 3 cents in the last seven days, the 2024 estimate fell 5 cents. This is a little early to be predicting the final score for 2024, but it does paint a gloomy picture.

So, drilling down into the numbers, we find that the secular move toward smarter technology, including connected devices, factories and homes, and connected cars provides a bedrock of strength to this stock. Revenues from the auto market, which accounts for more than half the revenue share, also continue to edge up. However, certain near-term factors, including the ongoing softness at industrial customers and the exposure to the consumer mobile market (given to demand fluctuations and consequent volatility in prices) are hurting the near-term outlook.

Shares of this Zacks Rank #3 (Hold) company have appreciated 10.5% over the past year.

Price and Consensus

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Magnachip Semiconductor Corp. (MX): Cheongju, South Korea-based Magnachip designs and manufactures analog and mixed-signal semiconductor platform solutions for serves consumer, computing, and industrial (including IoT and automotive) electronics OEMs, ODMs and EMS companies, as well as subsystem designers in Korea, the Asia Pacific, the U.S. and Europe. The company sells its products through a direct sales force, as well as through a network of agents and distributors.

The bulk of the business comes from its Power Solutions business, which is currently under some pressure from inventory rebalancing at industrial customers. Magnachip is, however, seeing continued momentum in design wins, particularly at auto OEMs. Demand from consumer, computing and communication markets remains strong this year. The business should become more profitable as newer, higher-ASP products grow in the mix and utilization improves.

The transitional foundry business, which accounted for roughly a sixth of revenue in the last quarter, will be wound down around the middle of the year and the capacity transitioned to the power business. Therefore, while the longer-term prospects as seen from new product innovation and design win momentum are strong, near-term numbers could move around a little bit.

That’s probably why, despite the 79% beat in in the last quarter, estimates haven’t moved up for either 2023 or 2024. Analysts expect that in 2024, the company’s top and bottom lines will increase a respective 22.6% and 27.9%.

#3 ranked Magnachip’s shares are down 28.5% over the past year.

Price and Consensus: MX

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