Demand for EVs, 5G bode well for chips despite sell-off

Sector still has huge appeal, but analysts are unsure the bottom has been reached yet

Global shortages of microprocessors meant 2021 was a record year for the companies making the units, but investors have soured on the sector despite continuing strong prospects for this year.

The Nasdaq Global Semiconductor Index, which follows 80 of the largest global semiconductor firms, has fallen 40 per cent year to date compared with the 29-percent decline for the Nasdaq Composite Index. Is it time to jump in?

Analysts say the sector still has huge appeal with energizers pointing strongly to rising longterm demand for all kinds of chips. Intheshortterm, aweakening appetite for new smartphones – the biggest single source of demand – is allowing companies to shift production to meet demand in other areas.

That’s easing bottlenecks slowly, but they will take some time to unwind. A recent estimate from Ajit Manocha, president and chief executive officer of industry association SEMI, which represents 2,000 companies involved in the chip design and manufacturing supply chain, says the global supply crunch will drag on for two more years. But that adds up to opportunities beyond short-term challenges.

“We will always have good and bad cycles, but if you’re confident about the broader trends they’re worth investing in,” says Matthew Bryson, managing director, equity research, at Wedbush Securities Inc. in Boston. He points to a handfuloftrends. Oneistherising demand for electric vehicles and more intelligent vehicles, generally. For example, a Ford Focus on the lot has about 300 chips, while Ford’s new Mustang Mach-E has about 3,000. The chips are used for things such as infotainment, warning lights and engine management.

Another trend is the Internet of Things, which is interconnecting devices. There is rising demand for artificial intelligence and smart software used in data storage.

The biggest trend is the transition to 5G smartphones, which need chips with ever more processing power. Here, manufacturers are readjusting short-term needs as the demand for these phones eases in China, which is one of the biggest markets for handsets.

“The question is how quickly demand can be reallocated,” Mr. Bryson says.

A new challenge has been Russia’s decision to limit the exports of inert gases such as neon, argon and helium that are used to make semiconductors. All three are used in the lasers used in the ultraviolet photo lithography that produces electronic chips. However, Mr. Bryson believes the market for these gases in chipmaking is quite small and the impact is likely to be slight.

Hans Albrecht, vice-president, portfolio manager and options strategist at Horizons ETFs Management (Canada) Inc. in Toronto, says the sell-off is part of a broader market repricing of technology stocks.

The downdraft has captured such leaders as Netherlandsbased ASML Holding NV, which produces the equipment necessary to manufacture microchips and has a virtual monopoly. Another victim is Nvidia Corp., best known for the graphic processor units used in gaming systems and high-end workstations. Both stocks are top holdings in HorizonsGlobalSemiconductorIndex ETF, comprising 18 per cent of the fund. Both stocks are down sharply, with Nvidia off 51 per cent year to date and ASML down 47 per cent.

Mr. Albrecht notes that Nvidia rose more than 500 per cent from its March, 2020, low to its August, 2021, high. So, the current sell-off seems steep, but the shares are still up 95 per cent from the low.

“They were in the right place at the right time,” Mr. Albrecht says.

He agrees that the sector fundamentals are stronger than ever, adding that the pandemic has actedasacatalystforautomationina way to cope with labour shortages and rising labour costs.

Meanwhile, Mr. Bryson notes that ASML’s sell-off has in part been about changing expectations. Six months ago, it looked as though there wasn’t going to be enough capacity to meet demand until 2023 or 2024. That sent the shares soaring. Now, with the global economy faltering, there are questions about whether that assumption is valid. One stock he likes is Advanced Micro Devices Inc. He says AMD has a 20-percent market share for chips used in personal computers. Just a onepointgainto21percentaddsupto 5-per-cent growth.