So you want to buy into semiconductors Part 1: They'll be back

It’s 2023 and according to the cinema of Ridley Scott and James Cameron, Planet Stockhead and everyone on it have already been vaporised several times – once as early as August 29, 1997 – by rampant, unchecked and largely (but not entirely) unfeeling semiconductors.

Sometimes referred to, but not by me, as integrated circuits (ICs) or microchips, these little fiddly bits are the building blocks of technology, or in the words of the sector’s peak body, the Semiconductor Industry Association (SIA), they’re the brains of modern electronics.

Or perhaps more effectively in the words of Kyle Reese…

Once you have achieved Sarah Connor’s look of understanding at the end of this clip, you’ll undoubtedly be wanting to have a position on semiconductors.

Hopefully this will help.

They’re really important.

They (McKinsey) say it’ll be a US$1 trillion industry by 2030.

Yet, after starting 2023 as if they were being chased by a James cameron semiconductor in the shape of the former governor of California, this month, Wall Street’s PHLX Semiconductor Sector Index is underperforming the S&P 500 by almost 10 percentage points its biggest benchmark lag since early 2019.

In fact, according to CNBC, semiconductors have only underperformed the benchmark index by greater that 7.5 percentage points during eight months over the last 20 years.

And someone tell me how the hell did Intel – the Intel – just end up losing US$2.8 billion, the biggest quarterly loss in the company’s history, revealed when it’s Q1 23 numbers dropped while you slept (emphasis on you).

Intel’s two fattest cash cow segments — client computing (they flog end user products for us) and its data centres (they flog data servers a la Amazon) both crashed around 40%.

That’s very odd because on the whole, semiconductor stocks and their ETFs have been rising all year on growing certainty that the sales downturn has done gone and bottomed out, while the concomitant surge in artificial intelligence (AI) technology and its associated FOMO is just kicking off.

What’s the fuss?

Let’s deal with the names to buy in a moment.

For now: Semiconductors – the hard to make secret sauce in everything that’s really fun today (cars, phones, weapons and stuff)… Basically anything useful in a pandemic or a career, a war or a childhood just won’t work properly without a good one.

Here’s a decent takeaway – In 2021, semiconductor unit sales reached a record 1.15 trillion-unit shipments, and last year, according to the super geeks at the Semiconductor Industry Association (SIA) global global sales topped US$$574 billion in 2022, the highest-ever annual total and an increase of 3.3% compared to 2021.

And while the PHLX Semiconductor Sector Index might’ve taken a backward step in April, it’s still up circa 17% for 2023.

Friend of the show – the VanEck Vectors Semiconductor ETF (SMH) – is up about 21.7%, for the year thus far, while in New York the benchmark iShares Semiconductor ETF (SOXX) is up 20% YTD to Wednesday night (…nothing special about Wednesday, just trying to provide some detail).

So as the general state of confusion and doubt pervades global markets, there’s a bright little apocalyptic sector shining quietly away in the overall gloom.

Demand. So very much demand.

Given we’re using chips right now – me to work, you to slack off – it’s fair to say semiconductors have been and will remain the single critical organ of technological development full stop and given the universal digitisation of our lives (be it healthcare, transport, money, food, war or peace), demand will continue to trend higher.

And now the new tech wave is upon us, and it’s really more of tsunami, everyone is going to badly need theirs – automotive, defence, white goods, China… since the outbreak of COVID-19 shortages that held back production and risked profits are top of mind.

The cloud, the Internet of Things (ioT), autonomous cars, Meta, gaming, wearables, edibles, drones and undressables.

VR, AI, 5G and crypto are but a few of the new paradigms fuelling cleverer, faster, trickier, more expensive, all-new next-gen chips which are what make AI tick and also provide enhancement in the product mix for semiconductor makers and diversity for investors.

But the supply of semiconductors has been, and remains, a tough gig.

History. Boring, boring history.

The pandemic exposed some yawning holes in the good guy’s global supply chain, as did the concurrent geopolitical discovery China was a bad guy. People panicked, I’m ashamed to relay. Demand rose as supply fell.

In October 2021, sales hit US$48 billion – an increase of 24% from October 2020.

Last year semiconductor sales totalled US$580.15b, a mild 4.5% year-on-year bump, but not shabby considering how much has been happening on the sidelines.

The COVID-snarl first sucked the air out of semiconductor producers who weren’t delivering and then to isolate China, the Americans banned anyone from playing with China, who’s bad enough not to be trusted with important tech.

That was good for most of the following chip stocks, even better is the US and the EU pouring about US$53 billion into the US CHIPS Act and some US$47 billion into the European version.

Both bits of legislation provide government funding mechanisms to supercharge homemade semiconductor making, create growth opportunities and to lubricate those supply chains that started all the problems during the pandemic years.

Lockdowns and health restrictions diminished production out of Asia, leaving surging demand for chips unmet just as everyone turned online for work, shopping and entertainment.

Naturally, the sight of President Joe Biden plunging a dagger through the heart and dreams of China’s burgeoning sector, by telling everyone to stop supplying China with cutting edge semiconductor tech has infuriated the Communist Party.

According to Deloitte, more than 80% of semiconductor manufacturing happens in Asia and the while US$100bn is some good cheese, the best case scenario over five years is that the boost will cut that share to 50% by decade’s end.

And with the nous and materials need to make the bloody things notoriously hard to get, there’s an old school arms race in the post.

Science and tech: the bit you can leave for later

Chips are made from pure elements, typically silicon or germanium, or compounds such as the European football team, gallium arsenide.

We can categorise microchips by 1) functionality or by 2) type of integrated circuitry.

In terms of circuitry, a chippie can be analog, digital, or mixed.

The difference between the analog and digital functions are in the electric signals they process.

In digital chippies, the signals are binary.

In analogs, the signals are continuous, meaning they can take on any value within a given range, and they use more traditional circuit elements (resistors, capacitors and occasionally inductors).

Rightio. in terms of what they do, let’s break it down to four categories:

Logic chips, Memory chips, application-specific integrated chips (ASICs) and system-on-a-chip devices (SoCs).

Of these Logic and Memory chips, are digital: they manipulate and store bits and bytes using transistors. ASICs and SoCs are mainly a mix of analog and digital.

Okay. Three main types of chippies: logic, memory, and analog.

Logic chips process tasks, memory chips store data and analog chips are the bridge between the real world and the digital world, taking a real-world sense, such as sound or light, and turning it into a digital signal.

Samsung’s the boss of the memory industry, a fragmented mess just as I was around 2012.

End markets are where we come in – the toys – smartphones, for example account for circa 25% of the US$600 billion, the sector generated this year, followed by PCs and data centres.

While chips undoubtedly have some sexy structural growth trends – evidenced by the lurid McKinsey 2030 estimate – they’re also undoubtedly a total sh*t to make, which makes the sector sluggish and vulnerable to cycles and some really stupendous capital intensity. In short. They’re hard to produce and cost a lot.

According to Ninety One’s Quality team, Charlie Dutton and William Nott, the chip value chain involves five types of companies.

The Designers, such as Nvidia or Qualcomm.

The Manufacturers – like TSMC – who make the chips.

The Integrated Device Manufacturers (IDMs) – such as Samsung or Intel – who do both.

The Electronic Design Automation (EDA) developers – including Cadence and Synopsys – they create the design software.

Capital equipment providers – make the machines which make the chips, (that go to Cotties) for this the Dutch are doing very well over at ASML.

The semiconductor industry is not without its challenges.

Back to Intel

As I tap away, the former darling of anything with a keyboard, Intel dropped Q1 financial data and believe me, it is not Kyle reece that’s come back to shepard Intel through the coming headwinds.

Revenue scraped in at US$11.7 billion, which seems a lot, but is down well over 35% on the same time last year.

Intel’s biggest loss in the company’s history, is also due to those cyclical forces we touched on, and the whole sectors exposed.

People aren’t buying PCs. IDC say sales are down 29.1% from the same time last year.

Bloody Samsung just reported a 95% profit car crash with spillover chip supply from pandemic times.

Excess inventory and a pause on global consumer electronics spend has taken the gloss of better set comapnies than Intel.

And yet…

And yet… regardless, semiconductor stocks continue to climb.

Worst. Quarter. Ever.

Today in New York brokers at both Benchmark and Wedbush upgraded Intel stock and raised its price target by 30% to US$30 from US$20.

Intel stock has closed over 4% higher.

Tomorrow on Stockhead, we go through the semiconductor stocks you should have in your portfolio on Judgement Day, when you’ll be sorry, but also rich and hopefully smug.