Why Semiconductors Are ‘The Oil of the 21st Century’

By Kirsteen Mackay

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Our 'Key Themes For 2022' is designed to help you identify and capitalise on the areas to watch out for. Here we have semiconductors.

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Semiconductors have been described as the ‘new oil’ of the 21st century. They underpin every facet of technology and the unassuming computer chip has become a focus of national security.

Chances are, you may not even know what a semiconductor is, or how crucial a piece of technology it is to your everyday life. But to give you an idea, earlier this year Goldman Sachs identified 169 industries being hit by the global chip shortage. That’s how wide the semiconductor reach has spread.

​​Semiconductor stocks have been rising for years. In the past five years the NVIDIA (NASDAQ: NVDA) share price has risen 1,288% and is up 150% year-to-date. Advanced Micro Devices (NASDAQ: AMD) tells a similar tale with its share price up 1,699% in five years and 70% year-to-date.

Can this growth continue in 2022, or will these prices see a correction?

The growing importance of semiconductors

In recent years, the rise of semiconductor stocks has been incredible. Anything and everything tech related requires computer chips - from PCs and gadgets to electric vehicles, medical robotics, and the data centers powering the cloud and AI.

The work-from-home trend coupled with a transition to electrification and technological advancements has accelerated growing demand for chips. High growth technologies including themes such as autonomous driving, AI, AR, 5G and 6G, automation and a shift to the cloud each contribute to the soaring demand for semiconductors.

Tightly concentrated supply

Demand for semiconductors covers a wide array of sectors, products, and companies, but the supply is very tightly concentrated. This can lead to bottlenecks in the supply chain, as has been highlighted over the past two years.

Qualcomm, Advanced Micro Devices, NVIDIA, and the Taiwan Semiconductor Manufacturing Company are some of the recent beneficiaries of chip stock enthusiasts. But it’s TSMC that manufactures the chips for the majority of the world’s fabless chipmakers.

The rise in chip demand has led TSMC and its rival Samsung to heavily increase their capital expenditure to replace and add vital equipment. One of their key suppliers is ASML (NASDAQ: ASML) which makes semiconductor equipment such as extreme ultraviolet lithography machines. Disruption to any one of these companies causes a knock-on effect around the world.

Indeed, TSMC and Samsung account for 71% of the global foundry revenue share. Therefore, being so dependent on so few companies is a big concern for the global supply chain and a matter for national security.

How long will the chip shortage last?

In February 2020, a Texas storm caused power outages at several major chip factories. Then COVID-19 hit and disruption in the sector was amplified. An already difficult situation worsened when a fire damaged a key auto chip factory in Japan, while drought in Taiwan has also been a problem.

Nevertheless, while supply was curbed, chip demand soared and the value of semiconductor stocks climbed too. The question is, will this trend continue in 2022?

It seems the chip shortage is likely to continue at least for the first half of 2022. But demand is also growing in step with the boom in electric vehicles and accelerating interest in developing the metaverse. 

With semiconductors powering the world it can seem like an obvious place to park your cash. But is that still the case?

As long as the demand is there, semiconductor stocks should theoretically be a good investment. But semiconductors are traditionally a cyclical investment, so there are still some risks investors should be aware of. 

Investment risks: semiconductor stocks

Despite delays, manufacturers are expected to continue providing chips. Therefore, the risks to these share prices lie in geopolitical concerns, a change in client/manufacturer relationships, and companies opting to make their own chips. 

Geopolitical tensions

One big problem the semiconductor industry faces is that very few companies produce the majority of the planet’s computer chips. Indeed, the Taiwan Semiconductor Manufacturing Company (NYSE: TSM) manufactures more than half the semiconductor chips produced globally. And US companies NVIDIA (NASDAQ: NVDA) and QUALCOMM (NASDAQ: QCOM) rely heavily on Asian manufacturers. 

With geopolitical tensions heated between the US and China in recent years, this gives cause for concern. Furthermore, tension between China and Taiwan has been escalating which is something Western countries want to avoid.

Changing relationships

In light of the chip shortages, several automakers have been going direct to source to negotiate with foundry companies like TSMC in an effort to secure their supply chains. This upsets the historical way of doing things but represents an opportunity for change. 

Investing in new factories

Building a new foundry is a hugely expensive undertaking, costing anywhere from $10bn to $20bn. Indeed, Samsung Electronics is planning a $17bn semiconductor manufacturing facility in Texas to be completed by 2024. Intel, TSMC and UMC each plan to build new plants in the coming years too. 

But it will take several years for additional manufacturing capacity to come online and demand is predicted to continue soaring. Therefore, semiconductor stocks still look like a decent play heading into 2022.

Big Tech may self-manufacture its chips

Apple (NASDAQ: AAPL) has hinted it plans to build its own semiconductor factory to power its foray into EVs. Amazon (NASDAQ: AMZN), Google (Alphabet (NASDAQ: GOOG)), and Meta (NASDAQ: META) may follow suit, but for now Meta is using AMD to provide its metaverse chip stack.

AMD, Intel, and Nvidia are the main US chip manufacturers to date. But big tech has an interest in taking manufacture into its own hands and the cash reserves to make it happen.

Third-generation semiconductors

A potential growth area in the semiconductor sector to watch is the shift from silicon to third-generation semiconductors. These are made using materials such as silicon carbide (SiC) and gallium nitride (GaN) and present a significant upgrade over previous types of semiconductor improving efficiency and cost. 

For instance, implementing these chips on an electric vehicle can optimize the cooling system, and the inverter footprint. Tesla already uses silicon carbide in some of its circuitry. Along with EV charging systems, silicon carbide is used in industrial power supplies, energy storage systems, battery management systems, and industrial power supplies. 

GaN transistors can handle much higher voltage and heat than traditional silicon. And GaN’s advantage is in high frequency applications, such as in the development of high speed wireless 5G and 6G products.

Third-generation semiconductors are a relatively new development. Indeed, we are at the beginning of a multi-decade secular shift to silicon carbide, so investing in this area carries more risk.

Wolfspeed, Inc (NYSE: WOLF) is designing innovative semiconductors using silicon carbide materials, power-switching devices and RF devices targeted for applications such as electric vehicles, fast charging inverters, power supplies, telecom, military and aerospace. It has $1.3bn worth of deals lined up for the next five years.

Navitas Semiconductor Corporation (NASDAQ: NVTS) is a developer of gallium nitride power integrated circuits that provide superior efficiency, performance, size and sustainability relative to existing silicon technology. Navitas went public via combination special purpose acquisition company (SPAC), LOKB in October 2021.

Are semiconductor stocks overvalued?

Some semiconductor stocks may have run up too quickly and could face a correction. Also, with auto manufacturers having been impacted by the chip shortages, they may have reduced cash to invest further going forward. Therefore, not every semiconductor company will thrive in the coming year.

NVIDIA (NASDAQ: NVDA) in particular has seen its share price jump five-fold since COVID hit. Meanwhile Broadcom (NASDAQ: AVGO) is up 190%.

NVIDIA and Broadcom outsource production to Asia so are reliant on smooth running supply chains.

Broadcom has grown nicely through acquisitions but its pace of growth is likely to slow unless it keeps this up. Its customer base is fairly concentrated with Apple contributing 15% to 20% of its revenue. If Apple sales fall, so do Broadcom’s and Apple has already indicated iPhone sales are slowing. Broadcom has a price-to-book value of 9 which is high, but it’s a lot lower than Nvidia’s P/B of 32.

While there are a few prominent semiconductor stocks that are probably overvalued, lesser-known stocks are more reasonably priced.

Inflation could lead to higher interest rates which will weaken the margins in tech stocks. This will cause fund outflows to rise and in turn negatively impact the share prices of premium stocks.

Here are some of the top US-listed semiconductor stocks:

Semiconductor ETFs

For those nervous of investing directly in individual semiconductor stocks, there are ETF options instead. These offer a way to diversify your portfolio and still enjoy the potential upside in investing in semiconductor stocks.

The iShares Semiconductor ETF (SOXX) has been steadily climbing since the great financial crash of 2009. But in the past year its popularity has exploded. SOXX tracks an index of 30 US-listed semiconductor companies.

The constituents include manufacturers of materials with semiconductors that are used in electronic applications or in LED and OLED technology and providers of services or equipment associated with semiconductors. 

VanEck Vectors Semiconductor ETF (SMH) is another. It tracks 25 of the largest US-listed semiconductors companies.

1. iShares Semiconductor ETF VanEck Vectors Semiconductor ETF
1. NVIDIA Corporation 1. Taiwan Semiconductor Manufacturing Company
2. Broadcom Inc.   2. NVIDIA Corporation
3. Intel Corporation 3. ASML Holding 
4. Qualcomm Inc 4. Advanced Micro Devices, Inc.
5. Advanced Micro Devices, Inc. 5. Analog Devices, Inc
6. Texas Instruments  6. Qualcomm Inc
7. ASML Holding  7. Broadcom Inc.  
8. Marvell Technology, Inc. 8. Texas Instruments 
9. KLA Corporation 9. Intel Corporation
10. NXP Semiconductors 10. Applied Materials
Top ten holdings by weight (largest to smallest)

As you can see, the top ten holdings are both very similar in both ETFs, albeit with different stock weightings. 

Semiconductor stocks in 2022

A chip shortage, a monumental shift to electrification and a booming bull market have converged to give clout to any company operating in the semiconductor industry. And now, the rise of the metaverse is amplifying the bullish take on semiconductor demand.

Traditionally, semiconductor stocks are known to be cyclical, which means they can go in and out of favour. With such a massive shift in secular demand, however, the current situation is often referred to as a supercycle, which means it’s likely to last for some time.

In a November report Goldman Sachs said it was focused on a rebound in semiconductor production and therefore cars. However, COVID-19 infections rising once more dampens this outlook.

In its GS Macro Outlook 2022, the company also stated:

“At present the stress on supply chains is substantial and inventories in semiconductors, durable goods, and energy markets are very low. In such an environment, even a moderate production outage resulting from COVID outbreaks in China, an energy demand spike related to a cold winter, or other short-term disruptions could have sizable economic effects.”

Nevertheless, it seems the chip shortage is likely to continue through the first half of 2022 and perhaps beyond. With the environmental push to electrification, demand for chips is soaring. Therefore, semiconductors are likely to continue being a trending theme of interest throughout the coming year.

This view is backed up by the World Semiconductor Trade Statistics (WSTC) forecast. The WSTC predicts annual global sales to rise by 25.1% in 2021 with a further 10.1% growth in 2022 to $606bn.

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This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.

Kirsteen Mackay does not hold any position in the stock(s) and/or financial instrument(s) mentioned in the above article.

Kirsteen Mackay has not been paid to produce this piece by the company or companies mentioned above.

Digitonic Ltd, the owner of ValueTheMarkets.com, does not hold a position or positions in the stock(s) and/or financial instrument(s) mentioned in the above article.

Digitonic Ltd, the owner of ValueTheMarkets.com, has not been paid for the production of this piece by the company or companies mentioned above.

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