NXP Semiconductors Offers A Nice House In A Sketchier Neighborhood

For better or worse, investor sentiment on sectors has a significant influence on the price performance of individual stocks; I’ve seen studies suggesting that 70% to 80% of a stock’s movement can be tied back to the sector. I mention that here because I think it’s a critical thing to understand with NXP Semiconductors (NASDAQ:NXPI) – the company’s differentiated end-market exposures have been helping the stock, and I like the long-term growth/valuation balance, but sentiment remains a risk with further downside to broader expectations about semiconductor demand in 2023.

Since my last update, NXP Semiconductor has outperformed the SOX by close to 15%, but lost about 15% of its value (modestly outperforming the wider market). I think auto and some parts of industrial will hold up in 2023, but I do expect a year-over-year decline in revenue and margins and it will likely take time for investors to come back to the name. All of that said, NXP shares look pretty meaningfully undervalued and worth a look from contrarian (or very patient) investors.

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NXP Semiconductors Offers A Nice House In A Sketchier Neighborhood

NXP Semiconductors Has Already Sold Off Ahead Of Potentially Rockier Demand

A year ago, NXP Semiconductors (NASDAQ:NXPI) was a consummate example of “love the company, don’t love the stock (or the valuation, more precisely)”. Since my last update on the company, the shares have fallen about 18%, underperforming the SOX by around 17%, while names I preferred like onsemi (ON) and STMicro (STM) have done notably better. While nothing is fundamentally wrong with NXP, I think the weakness can be tied to limited margin upside over the next few years, as well as risk/vulnerability in the coming normalization (if not down-cycle).

I think a lot of the correction may already be in the shares and I’m increasingly intrigued by the value I see here. Although there are better plays to leverage auto electrification, NXP will generate growth here, and I like the company’s leverage to industrial automation, edge intelligence, and what I’d call “non-traditional” mobile (UWB in particular). I certainly acknowledge a risk that I may be underestimating the downside if the cycle really corrects sharply, but I still think NXP is set for high single-digit revenue growth and strong margins that can fuel an attractive long-term return from today’s price.

 

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NXP Semiconductors Has Already Sold Off Ahead Of Potentially Rockier Demand

Attractive Long-Term Growth Opportunities Support NXP Semiconductors Beyond This Near-Term Demand Surge

The entire semiconductor space may be running hot today, but with volume and content growth in autos, recovery and new market opportunities in industrial and communication markets, and lean channel inventories, it may take some time for record-high lead-times to shrink. And even when they do (they always do…), NXP Semiconductors (NXPI) has strong multiyear secular growth drivers that can cushion the blow relative to other chip companies.

I’ve definitely underestimated the Street’s enthusiasm for chip names, but I at least got it right in preferring NXP within the space, as the shares have risen more than 75% since my last update – handily outperforming the sector and more direct peers like Texas Instruments (TXN) and Microchip (MCHP), though Renesas (OTCPK:RNECY) and ON (ON) have done even better (though ON with a restructuring/self-improvement theme).

I don’t know when the music is going to stop for the chip sector; in the past, high lead-times have led to weaker results down the road, but maybe this cycle will be different. I don’t really like the long-term prospective returns in the space now, but I do like NXP’s relatively better growth outlook. If management can really deliver on margin leverage (a challenge for the company in the past), so much the better. I can see the appeal in NXP from better growth prospects and a “have to own something” standpoint, though I don’t plan to chase the shares up here.

 

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Attractive Long-Term Growth Opportunities Support NXP Semiconductors Beyond This Near-Term Demand Surge

NXP's Share Price Already Assumes A Lot Of Growth And Improvement

Quality semiconductors aren’t by and large selling all that cheaply anymore, as the sector has recovered sharply from March panic-low prices as the Street has gotten more comfortable with the likely downside in Q2 and Q3 from the Covid-19 business disruptions. In the case of NXP Semiconductors (NXPI) we have a story where there’s significant growth potential as well as self-improvement potential (execution), but a lot of that already appears to be in the share price today.

I like NXP’s leverage to electric vehicles and advanced auto content growth, not to mention its strong position in markets like microcontrollers (or MCUs), near field communication (or NFC), high-power RF, and IoT. I also see meaningful potential for the company to improve gross and operating margins. The problem is that today’s valuation now takes those improvements as largely a given and I think there are better values in the high-quality chip category.

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NXP's Share Price Already Assumes A Lot Of Growth And Improvement

Marvell Executing On A Once-Underappreciated Transformation Strategy

I liked Marvell (MRVL) back in September of 2018, as I thought the Street was too focused on the near-term challenges of integrating Cavium and not enough credit to the transformation underway in the business. While the shares dropped another 20% from that point in time with the SOX, the shares have since rebounded more strongly, and the shares now sit about 20% higher than they were at the time of the last article (while the SOX is down about 4%).

I continue to like the direction Marvell is going. Significant wins in 5G (primarily with Samsung) could translate into more than $700 million of incremental revenue, and the company has been building up its ASIC capabilities such that I believe the company has a chance of emerging as a viable second-source rival to Broadcom (AVGO) in time and shifting more of the business’s center of gravity towards growth markets and away from storage.

What I don’t like so much is the current valuation. Marvell has attractive end-market exposure for the next 12-18 months and looks better-positioned for the near-term growth that Wall Street loves so much, but I think the valuation is a tougher sell now.

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Marvell Executing On A Once-Underappreciated Transformation Strategy

Microchip Technology Bumps Along The Bottom

I’ve been writing for a little while now that I thought the semiconductor rally was ahead of itself, and that between ambitious expectations for a second half bounce, high inventories, shrinking lead-times, and ongoing uncertainty with trade relations with China, there were a lot of factors in play that could blunt the “V-shaped” rally so many investors seemed to be counting on. To that end, I thought Microchip Technology (MCHP) shares were ahead of themselves in the short term back in February, and the shares are now pretty much flat versus that last article.

With Microchip revising down for the fourth time, and blaming it largely on the tariff issue, I wonder if this will be the moment of reckoning for the larger chip space. Either way, I still see some downside risk over the near term. Specific to Microchip, I do like the business and management’s active approach to inventory management and M&A, even if I think they are occasionally too bullish on guidance. High debt is a risk (almost 8x my FY20 FCF estimate), and the shares don’t look like a margin bargain on short-term metrics, but I’d keep an eye on any sell-off, as I think the shares can go higher over the long term.

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Microchip Technology Bumps Along The Bottom

The Market Seems To Be Counting On A Quick Rebound At Maxim Integrated

There are a lot of meaningful positives with Maxim Integrated (MXIM). Not only has this company successfully transitioned to a more attractive end-market mix driven by auto electrification and factory automation, the company has also meaningfully upgraded its profitability by pruning lower-return businesses, bringing more distributors into the mix, and outsourcing more production. With strong margins, above-average growth potential, and a strong business anchored in power management and interface ICs, I believe Maxim can do well on its own and/or become an attractive acquisition target.

All that said, there are limits to what I’ll pay and Maxim is trading beyond those limits. Recent results and guidance should serve as a reminder that Maxim’s better mix doesn’t immunize it from macro challenges, and I am concerned that investors have gotten too cavalier about assuming a quick return to growth across the chip sector. In the $50’s, Maxim just looks too expensive to me relative to the risks of further setbacks/revisions in the sector.

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The Market Seems To Be Counting On A Quick Rebound At Maxim Integrated

A Brutal Miss-And-Lower-Guide Has Silicon Labs' Growth Premium In Question

It’s generally accepted by most investors that you have to pay up for growth, but with the recent weak performance at Silicon Labs (SLAB), including an ugly guide-down for the first quarter, I’m concerned that these shares could be liable to investors asking “wait … why are paying up for this?” I had previously expressed my view that Silicon Labs was entering a rocky operational stretch, but this is a little worse than I’d expected, and the company definitely needs markets like IoT, isolation, and timing to start coming through in the second half of 2019.

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A Brutal Miss-And-Lower-Guide Has Silicon Labs' Growth Premium In Question

Renesas Pummeled On Inventory Corrections And Worsening Macro

Japan's Renesas Electronics (OTCPK:RNECY) (6723.T) is a microcosm of what worries me about the semiconductor industry heading into 2019. Elevated lead times and strong orders lead Renesas, its distributors, and its end-customers to build up inventories, and those inventories eventually got much too large, leading to a painful reset as demand has tapered off. In addition to this inventory correction process, there are growing worries about auto unit demand growth in 2019, not to mention demand from factory automation, appliance, and consumer device end-markets. More specific to Renesas is also, I believe, a growing concern over how the company stacks up competitively in the evolving auto semiconductor landscape.

Although I take the risks of share loss to competitors seriously, I think the shares are pricing in an extreme level of pessimism for Renesas's future. Even with near-term margin issues likely capping some of the upside, I believe the shares are just too cheap for one of the global leaders in microcontrollers and a company set to benefit from the acquisition of Integrated Devices.

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Renesas Pummeled On Inventory Corrections And Worsening Macro

STMicroelectronics Discounting A Truly Scary Semiconductor Cycle

I suppose that relative to the perpetually optimistic sell-side, I’m bearish on the semiconductor sector over the next 12-24 months, but I believe the share price of STMicroelectronics (STM) (or “STM”) is now pricing in a truly frightening level of pessimism about the near-term outlook for the industry. STM will certainly face stiff competition from companies like Infineon (OTCQX:IFNNY), ON Semiconductor (ON), Renesas (OTCPK:RNECY), Cypress (CY), and NXP Semiconductors (NXPI) in the coming years, but I believe the company’s strong position in MCU, power management, and sensing is being underrated now, not to mention the possibility for future volume-driven margin gains.

I think STMicroelectronics should be more fairly valued in the range of $17.50 to $21.50, a wide range to be sure, but one reflects the consistent gap between longer-term adjusted discounted free cash flow (which tends to produce lower targets) and the short-term multiples-based approaches that are typically more commonly-used on the Street.

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STMicroelectronics Discounting A Truly Scary Semiconductor Cycle

Cypress Semiconductor's Value Obscured By A Growing Wall Of Worry

Given the roughly 15% drop in the SOX over the past six months, it’s not too hard to find chip stocks that look more reasonably-valued, if not cheap, these days. The catch, though, is how well current expectations factor in the numerous risks that seem to be mounting early in 2019 – shrinking lead-times, weakening auto and industrial markets, weakening memory pricing, and so on. Although I do like the business mix at Cypress (CY), and I believe the company is well-placed to gain share in the auto and IoT markets in the years to come, weaker near-term conditions are definitely a risk and I think it will take some time before a margin-driven mid-to-high teens fair value gains any real traction in the market.

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Cypress Semiconductor's Value Obscured By A Growing Wall Of Worry

Microchip Looks Undervalued, But There Are Short-Term Challenges To Consider

Buying good companies on stumbles is a time-tested strategy, but one that stills carries risk – it’s not always easy to separate a stumble from a prolonged tumble down the stairs. In the case of Microchip (MCHP), while issues related to its recent Microsemi purchase loom larger in the short term, I’m a little more concerned about the potential impact of extended lead times and weakening demand in important end-markets.

I believe Microchip has proven itself to be a well-run chip company, and I like the company’s diverse capabilities across microcontrollers (or MCUs) and analog, as well as the new opportunities brought in with the Microsemi deal (including FPGAs, timing products, data center products, and so on). Although this may not be the ideal time to buy given sentiment toward the semiconductor space, the long-term value proposition makes this a name worth considering for more value-driven investors.

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Microchip Looks Undervalued, But There Are Short-Term Challenges To Consider

Power Integrations' Revenue Re-Acceleration Looking More Like A 2019 Event

All you need to be a successful semiconductor loved by investors is perpetual double-digit revenue growth, 60%-plus gross margins, 30%-plus operating margins, a rich buyback, expanding end-markets, and optionality on both ends of the M&A spectrum. See? Simple.

Sarcasm aside, Power Integrations (POWI) has been in a tougher spot recently, with the company missing a few times on the top line and lowering guidance. A slowdown in smartphones and communications and delays in other programs has pushed revenue growth down from the double-digits, and the margins remain sub-optimal. Add in a relatively robust valuation, and I’m not too surprised that the shares have lagged the SOX by a significant degree since my last update, not to mention underperforming peers/rivals like ON Semiconductor (ON). With the shares already pricing in a return to double-digit revenue and a mid-20%’s operating margin, it’s tough for me to see a compelling risk-adjusted opportunity here.

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Power Integrations' Revenue Re-Acceleration Looking More Like A 2019 Event

Renesas Going Through A Rocky Patch, But The Future Prospects Look Undervalued

"Buy the pullback" is one of the oft-used pieces of advice that is easier said than done but can nevertheless be profitable for patient investors. The semiconductor sector has certainly cooled, and Renesas Electronics (OTCPK:RNECY) is likely to see some weak reported results in the near-term, but this looks like a story that has some legs over the longer term.

Renesas is certainly looking at more competition in its core auto semiconductor market, but I wouldn't ignore the strong position it has built for itself in microcontrollers and SoCs, nor the opportunity to benefit from significant growth in semiconductor content in the auto sector. With mid-single-digit long-term revenue growth and low-to-mid teens operating margins, the stock looks undervalued enough today to merit a closer look.

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Renesas Going Through A Rocky Patch, But The Future Prospects Look Undervalued

Strong Execution On IoT Is Taking Silicon Labs To A New Level

Chip company Silicon Labs (NASDAQ:SLAB) was already doing pretty well with its Internet of Things (or IoT) business back in the summer of 2016, but I underestimated the company's ability to continue to leverage that driver. As IoT is becoming an increasingly real driver, it is having a solidly positive influence on Silicon Labs' performance, and the shares are now about 40% higher than when I last wrote on the company.

Silicon Labs isn't going to have the IoT opportunity all to itself; Qualcomm (NASDAQ:QCOM) (through NXP Semiconductors (NASDAQ:NXPI)), Microchip (NASDAQ:MCHP), Texas Instruments (NYSE:TXN), and STMicroelectronics (NYSE:STM) among others are going to be competing fiercely in this growing market. Silicon Labs' strong positioning across the range of connectivity options and in mesh networking are important drivers, but other rivals have their own areas of strength in MCUs, security, sensing, and so on. What's more, the valuation is now considerably more demanding, and with it come much higher expectations for the lead IoT and Infrastructure businesses.

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Strong Execution On IoT Is Taking Silicon Labs To A New Level

Gemalto In A Bruising Transition Period

It has been a while since I've written on Franco-Dutch digital security company Gemalto (OTCPK:GTOMY) (GTO.PA) (GTO.AS). I thought the shares looked interesting back in February of 2013 on the potential to benefit from growing 3G/4G adoption and the conversion to EMV chip cards, and the shares did alright in the following two years (albeit with volatility). Starting around mid-2015, though, circumstances changed dramatically for the worse in the company's mobile SIM card business, and recent pressures from the payment/EMV business have made things worse.

I believe the company, and the shares, are in a tough transition period. I don't think mobile SIM cards will ever be a driver for the business, and I'm not sold on the prospects for mobile payments and contactless EMV cards to drive meaningful long-term value. I do believe, though, that the company's position in security platform/services, enterprise security, government, and machine-to-machine can drive worthwhile growth in the years to come.

The shares do look undervalued today on the basis of revenue growth in the neighborhood of 4-5% and FCF growth around 7-9%. That said, for those who can stomach the risk of missing out, waiting a little longer to make sure there isn't another shoe to drop may be a better decision in terms of long-term risk/reward. In terms of the mechanics of buying the shares, the U.S. ADRs do trade, but there is better liquidity in the European markets and most brokers now handle these trades at reasonable prices.

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Gemalto In A Bruising Transition Period

Qualcomm Seems Frustratingly Reactive

A little over a year ago, I thought Qualcomm's (NASDAQ:QCOM) valuation was potentially interesting, but I couldn't really recommend the shares due to margin erosion and what I saw as a lack of management initiative to make meaningful changes to grow the business. The shares are basically flat since then, due in part to ongoing worries about market share, pricing, and volume in handsets, as well as a lack of movement on the M&A front.

Really very little has changed regarding my outlook and feelings about Qualcomm. I think management's targets and goals for growth outside of handsets are exceedingly ambitious, and I think the royalty issues could linger on as a perpetual concern. I do find the prospect of major M&A to be interesting (most likely NXP (NASDAQ:NXPI)), though I stand by my comment last year that Nvidia (NASDAQ:NVDA) would have been a better long-term idea. While there is some value here, quite a bit of skepticism, and opportunities to do better, Broadcom (NASDAQ:AVGO) offers similar value and what I believe is a higher-quality business and management team.

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Qualcomm Seems Frustratingly Reactive

Execution And Opportunity Continue To Drive Broadcom

Broadcom's (NASDAQ:AVGO) recent stock market performance hasn't been all that special. Since my last update on this leading chip company, the shares have done a little better than the NASDAQ, but have lagged the SOX pretty meaningfully, not to mention lagging other notables like Qualcomm (NASDAQ:QCOM), Texas Instruments (NYSE:TXN), and Intel (NASDAQ:INTC).

I'm not worried. Sure, as a Broadcom shareholder I'd love to see the stock performing better, but the company's financial reports have been positive and I believe there are strong tailwinds for both the wireless and wired businesses. Uncertainty around M&A is a risk factor, as are general market/economic conditions and competition, but I believe Broadcom has the quality to be a long-term holding and the valuation today isn't bad.

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Execution And Opportunity Continue To Drive Broadcom

Execution Remains ON Semiconductor's Biggest Opportunity ... And Its Biggest Risk

While I thought ON Semiconductor (NASDAQ:ON) was undervalued back in February, the company's history of iffy execution relative to past margin targets and the cyclical weakness in the analog chip space were offsetting concerns. The shares are up almost 50% since then, though, which is about 10% better than the performance of the SOX over that same time, not to mention Texas Instruments (NYSE:TXN) and NXP (NASDAQ:NXPI) (though STMicroelectronics (NYSE:STM) was quite a bit closer).

Investors are certainly feeling better about the health of the chip space, and metrics like lead times would seem to support that. With ON, there's also above-average potential to grow on the back of increasing content in autos, phones, and computers. Even more significant for ON, though, is the potential to drive better margins (where the historical record is admittedly mixed) and drive real synergy from the upcoming merger with Fairchild (NYSE:FCS).

I come up with a wide range of potential values for ON Semiconductor and that seems appropriate given the confounding mix here of the potential to do better and the historical realities of the company's performance. Better days are certainly possible… but then, so too is an "Atmel (NASDAQ:ATML)-like" outcome of years and years of frustrating performance. My core DCF fair value (including Fairchild) is around $10.50 now, but there is definitely potential into the mid-to-high teens if management truly can maximize its growth and margin opportunities.

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Execution Remains ON Semiconductor's Biggest Opportunity ... And Its Biggest Risk

Efficiency Trumping Growth At Microsemi For Now

As the larger semiconductor industry continues to bump along with little-to-no organic growth, Microsemi (NASDAQ:MSCC) too has found its organic growth opportunities somewhat limited in the near term. The good news, though, is that the company has been making real progress with cost-cutting and debt repayment, putting it in a good position to reap meaningful operating leverage and profit growth when underlying demand improves.

Microsemi's quarter was pretty nearly on target with my model, so my post-earnings changes aren't significant. The shares have done alright over the last year, matching the SOX index and beating the major indices, but I don't see major upside left based on the fundamentals. I do think there is a possibility that the growth outlook improves toward the end of the year (and higher revenue drives a higher fair value), but with a 25% move since my last article, I regard this more as a "quality hold" to buy on pullbacks than a must-buy at today's price.

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Efficiency Trumping Growth At Microsemi For Now