The past year has been challenging for the global semiconductor sector. The weakness, expected to persist throughout 2023, has been the result of falling revenues caused by myriad factors, including pandemic-related disruption, geopolitical risk and mounting cost pressures.
Fortunately, while the consumer demand has been weak owing to persistent inflation and declining disposable incomes, it has been offset by the more resilient enterprise demand, especially for advanced high-tech applications. As a result, worldwide semiconductor revenue eked out a 1.1% growth in 2022, up from US$595 billion in 2021, according to Gartner.
The recent declines have created a sizeable disconnect between the market price and the fundamental valuation of leading chip stocks. Opportunistic investors may want to keep on their radar the following semiconductor names that are large in size, boast leading market share and have excess cash to navigate industry headwinds, according to Morningstar research.
Chip giant Qualcomm (QCOM) makes wireless technology and designs chips for smartphones. The company's key patents revolve around 3G and 4G networks, but it is also a leader in 5G technology. As the world's largest wireless chip vendor, supplying nearly every premier handset maker with leading-edge processors, Qualcomm's IP is licensed by virtually all wireless device makers. It also sells chips into automotive and Internet of Things markets.
“We expect Qualcomm’s licensing business, the driver of the firm’s narrow moat rating, to continue generating solid cash flows, due to the ongoing ramp of 5G,” says a Morningstar equity report.
The company has been able to withstand government investigations into its business model and maintain adequate royalty rates, which will continue over time, says Morningstar strategist Abhinav Davuluri. Moreover, Qualcomm remains at the forefront in 5G network proliferation, adds Davuluri, who puts the stock’s fair value at US$140.
Qualcomm’s narrow economic moat stems from intangible assets and the firm’s ability to collect royalties over the next decade. “The firm has historically held a competitive edge in baseband chips, which are critical to devices’ inherent ubiquitous connectivity,” says Davuluri.
World’s largest logic chipmaker, Intel (INTC) designs and manufactures microprocessors for the global personal computer and data centre markets. Intel's server processor business has benefited from the shift to the cloud. It’s also been expanding into new adjacencies -such as the Internet of Things, artificial intelligence, and automotive -- as the PC market declines.
“Intel is the market share leader in the integrated design and manufacturing of microprocessors found in PCs and servers,” says a Morningstar equity report, adding that “the data centres used to facilitate the information stored, analyzed, and accessed by various front-end devices are mostly run with Intel server chips.”
The chipmaker historically differentiated itself via the execution of Moore's law, which predicts transistor density on integrated circuits will double about every two years, meaning subsequent chips have substantial power, cost, and size improvements.
“This scaling advantage was perpetuated through higher-than-peer-average R&D and capital expenditure budget that allows it to control the entire design and manufacturing process in an industry where the majority of competition focuses on only one phase,” asserts Davuluri, who pegs the stock’s fair value at US$35.
Advanced Micro Devices (AMD) designs microprocessors for the computer and consumer electronics industries. Personal computer and data centre markets drive the majority of its sales. The firm also supplies the chips found in popular game consoles including the Sony PlayStation and Microsoft Xbox. AMD has also been making strategic acquisitions to diversify its business and augment its opportunities in data centre and automotive markets.
“AMD operates in the x86-based duopoly with Intel that dominates the PC and server CPU markets,” says a Morningstar equity report, stressing that “AMD benefits from intangible assets related to its x86 instruction set architecture license and chip design expertise, which gives us confidence that the firm will generate excess returns over its cost of capital over the next decade.”
X86 is a type of instruction set architectures (ISA) for computer processors.
The chip manufacturer outsources its chip designs to third-party foundries such as Taiwan Semiconductor Manufacturing and GlobalFoundries. “While AMD has historically been a smaller x86 chip supplier than Intel, it has recently offered materially more competitive products across all of its segments, thanks to a combination of strong execution in new innovative chip designs,” says Davuluri, who appraises the stock to be worth US$115, and projects a top-line compound annual growth rate of 13% through 2027.
