Renesas Electronics Positively Leveraged To Stronger Autos And New End-Market Opportunities

In the rock-paper-scissors world of the stock market, apparently an auto market recovery trumps a major acquisition and an earthquake, as Renesas Electronics (OTCPK:RNECY) (6723.T) shares have appreciated around 80% since my last update on the company, handily outperforming the SOX index over that time, as well as other auto-driven semiconductor companies like Infineon (OTCQX:IFNNY), NXP Semiconductors (NXPI), and STMicro (STM), though ON Semiconductor (ON) has basically kept pace.

I liked the bid for Dialog Semiconductor (OTCPK:DLGNF), particularly as the company seems to be deprioritizing the Apple (AAPL) aspects of that business and is focused instead on taking Dialog’s core technologies in power management, connectivity, and advanced mixed signal chips and reapplying them to end-markets like autos, industrial, and IoTs.

Renesas shares have had a good rally, but they don’t yet look overvalued (or even fairly-valued) to me yet. While I can understand uncertainties about the benefits of the Dialog deal, I believe Renesas may also be lagging because it doesn’t tell quite as exciting of a story where autos and xEVs are concerned. While it’s true that Renesas doesn’t have the leverage to electrification of Infineon, STMicro, or ON, I wouldn’t ignore the long-term opportunities in areas like ADAS, nor non-auto opportunities like IoT.

 

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Renesas Electronics Positively Leveraged To Stronger Autos And New End-Market Opportunities

Renesas' Acquisition Of Dialog Is A Win-Win

It’s an odd thing when two companies you really like get together. I’ve thought for some time that both Japan’s Renesas (OTCPK:RNECY) and the U.K.’s Dialog Semiconductor (OTCPK:DLGNF) were underrated and undervalued by the Street, though both have done well since my last write-ups on the companies (Renesas here and Dialog here).

Apparently, Renesas agrees that there’s more to Dialog than the Street thinks and that the company’s technology can do a lot more. On February 8, Renesas and Dialog announced that Renesas will acquire Dialog for EUR 67.50 per share, and add Dialog’s capabilities in power management, connectivity, and other mixed-signal chips to its own capabilities in MCUs, SoCs, and mixed-signal.

I believe Dialog shareholders are getting a fair price, but given the sentiment in the sector, you could perhaps argue that “fair” is undervalued. In any case, I expect little risk of the deal not going through. While I believe Renesas shares remain attractive, whether the modest spread between the deal price and Dialog's share price (EUR 2/share as of this writing) is sufficient reward for a trade is harder to say.

 

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Renesas' Acquisition Of Dialog Is A Win-Win

Renesas Looks Undervalued As The Business Finally Bottoms Out

I was bullish on Renesas Electronics (OTCPK:RNECY) back in July and the shares have performed quite well since then (up 34%). But I’ve been bullish for a while and these shares have lagged since 2018, so I’m not exactly doing a victory dance here.

Renesas has struggled through not only a tough correction in the auto and industrial markets it serves, but also from plenty of self-inflicted issues regarding inventory and margins. The company’s weak performance versus its auto end-market has also raised valid questions about its competitiveness and long-term market share.

I’m still concerned about Renesas’s long-term market position, though it does still seem to be solid with its core Japanese OEM customers. I’m also more enthusiastic about the company’s plans to rationalize fabs over time, boosting margins and FCF. Although the near-term outlook for auto is still challenging (both company-specific and industry-general issues), I believe Renesas is in better shape and is still undervalued – one of the relatively few names in its peer group where I can say that.

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Renesas Looks Undervalued As The Business Finally Bottoms Out

Renesas Looking For A Clean Start With New Leadership

To say that the inventory correction process at Renesas Electronics (OTCPK:RNECY) has been painful would be tantamount to saying that Michael Jordan was pretty decent at basketball. Renesas has been hammered not only by a global slowdown in auto production but also significant weakness in China and among its Japanese clientele that serves Chinese customers (like Fanuc (OTCPK:FANUY), Mitsubishi Electric (OTCPK:MIELY), and so on). On top of that, it looks like my worries about market share loss have proven true, with even management acknowledging share loss in its core auto business (although they claim it's due mostly to discontinuing lower-margin products).

When I last wrote about Renesas, I thought there could be at least one more significant correction to expectations on the way, and that has been the case, but the pessimism on the shares was such that they're more or less flat with where they were at the time of that last article. With the inventory correction process mostly over, a new CEO, and IDTI now in the fold, Renesas should be able to return to a more growth-driven plan. I do believe the shares are undervalued, but there are still outsized risks to consider with this stock, including suboptimal ADR liquidity.

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Renesas Looking For A Clean Start With New Leadership

Infineon Managing To Weaker Assumptions About The Chip Recovery Cycle

With Infineon (OTCQX:IFNNY) being one of the rare semiconductor companies to challenge the rally in chip stocks by pointing to a lower, slower recovery, it’s not surprising that these shares have lagged the SOX this year, not to mention peers like ON Semiconductor (ON) and STMicro (STM). Japan’s Renesas Electronics (OTCPK:RNECY) has been down in the doldrums with Infineon, but then there are some pretty serious margin (and possibly market share) issues at that large MCU player.

At this point, it’s just too soon to tell whether what’s going on at Infineon is an issue of company-specific end-market/customer mix, market share shifts, or a more aggressive approach to dealing with inventory and demand challenges. Given the relative valuations and recent performance trends, I’d probably list my preference order as STM, ON, Infineon, Renesas, but Renesas has a lot of upside if they get back on track, ON has more inventory risk, and Infineon may prove to be managing this downturn the best when it’s all said and done.

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Infineon Managing To Weaker Assumptions About The Chip Recovery Cycle

STMicroelectronics Still Counting On A Big Finish To 2019

When I last wrote about STMicroelectronics (STM), I cautioned against trying to get too cute about timing a bottom for this leading chip company, particularly when the shares looked undervalued even on the assumption of a tougher 2019. The shares have since risen another 15% or so, lagging a broader chip market rally that has surprised me in its intensity.

I continue to like STM, though perhaps not quite as much as before given the rising valuation, and I like the company’s broad leadership across microcontrollers, PMICs, sensors, MEMS, silicon carbide, and so on, as well as the diverse market exposure to attractive markets like autos, industrial, IoT, and imaging. Although I am still concerned that the big second half rebound that so many chip companies are counting on may disappoint, I still think STM is a stock worth buying and owning today.

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STMicroelectronics Still Counting On A Big Finish To 2019

Guidance From STMicroelectronics Suggests A Stronger Second Half Than Many Expected

For better or worse, short-term stock price performance is mostly a game of expectations, and expectations going into this reporting cycle were for semiconductor companies to lower guidance for the first quarter. While Xilinx (XLNX) was a notable exception, that expectation has held true conceptually, with Texas Instruments (TXN), Intel (INTC), and STMicroelectronics (STM) all guiding down, but the magnitude of the revisions seem to be less severe than feared.

Specific to STM, I’m still bullish on these shares even after a double-digit pop post-earnings. The market is still not sold that the company’s cost structure and operating philosophy have really changed such that a downturn won’t hammer margins, and I believe that there is still room for the company to surprise. Although I’m a little concerned that management’s full-year targets for 2019 are aggressive and that the sector could see a second cut to numbers in three months, I like these shares below the high teens.

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Guidance From STMicroelectronics Suggests A Stronger Second Half Than Many Expected

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

Infineon's Rich Content-Growth Mix Going Up Against A Tougher Chip Cycle

With high lead times leading the Street to expect serious inventory corrections and disruptions to sales and orders, leading power management semiconductor companies like Infineon (OTCQX:IFNNY), STMicroelectronics (STM), and ON Semiconductor (ON) have underperformed a weakening semiconductor sector over the past year. Although end markets like electric vehicles, wireless charging, and industrial automation continue to grow (and likely will continue to grow in 2019), lead times are still very high and Infineon is investing considerable resources to support future demand, pressuring free cash flow, and margins in the near term.

Infineon will see significant competition from STMicroelectronics and ON in key areas like auto power semiconductors, but there's likely to be significant underlying demand over the next 10 to 15 years. Infineon is, likewise, well-placed to benefit from the "inverterization" of home appliances, growth in factory automation, and growth opportunities in data centers and 5G wireless. I am worried that the semiconductor down-cycle could be worse than currently expected, but the shares are already discounting a lot and I do see upside from here.

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Infineon's Rich Content-Growth Mix Going Up Against A Tougher Chip Cycle

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

ON Semiconductor Feeling The Heat From The Street

That companies like ON Semiconductor (ON) will survive the next phase of the semiconductor cycle is not in doubt to me, but what this corrective phase will look like is still very much up for debate. It’s not unreasonable to think that the adjustment from recent record highs in lead-times will lead to a more painful cycle than that seen in 2015, but then there are secular growth drivers helping ON Semiconductor that I’m not going to just dismiss out of hand.

When I last wrote about ON I said “…but the risk of near-term turbulence is something to consider …”, but I didn’t really think the shares would drop by roughly one-third in just a few months. Certainly the sector-wide declines in semiconductor stocks are being driven more by fear and momentum than truly horrible conditions (and/or outlooks), but that doesn’t make the losses sting any less. Moreover, with no real end in sight to the trade dispute between the U.S. and China, it’s tough to know whether the industry can manage a graceful dismount from the record lead-times as demand slows in markets like auto, handsets, data centers, and industrial.

I think the valuation is still quite interesting for long-term investors, but I also think the near-term still holds outsized risks. While the shares should be trading at least in the low $20’s, sentiment is poor now and semi stocks are likely to stay in the doghouse through at least the middle of 2019.

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ON Semiconductor Feeling The Heat From The Street

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

Renesas Seals The Deal With Integrated Device Technology

It didn’t take long for the rumors of Renesas Electronics’ (OTCPK:RNECY) (6723.T) interest in Integrated Device Technology (IDTI) to bear fruit, with the two companies announcing late Monday night that Renesas had agreed to acquire IDTI for $49/share in cash. The deal structure is a fairly straightforward cash transaction, with Renesas anticipating a deal close in 2019 pending regulatory approvals.

Although Renesas is paying a little more than I expected, management’s target for post-merger revenue synergies was higher than I had modeled. Even with a modest discount to those projections (though Renesas has exceeded expectations with its Intersil integration), this looks like an accretive, worthwhile deal for Renesas that will augment its auto business, add valuable analog/mixed-signal capabilities, and better diversify Renesas’s auto-heavy business mix. Although Renesas shares have been hammered this year as the company goes through a tough inventory adjustment cycle, the long-term value looks interesting at these levels.

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Renesas Seals The Deal With Integrated Device Technology

Renesas And IDT - It May Or May Not Be True, But It Makes Some Sense

Once a hotbed of M&A activity, deal activity in the semiconductor sector has cooled off considerably this year as buyers are digesting their meals and potential acquirers are trying to make sense of the current market, given lengthening lead times in many product categories, rising trade tensions, and some concerns about deal approval criteria. Even so, I’ve continued to maintain that Integrated Device Technology (IDTI) is a “when, not if” seller and Japan’s Renesas (OTCPK:RNECY) is a “when, not if buyer,” and while I hadn’t previously tied these two together, there’s a rumor now that Renesas is close to a deal to acquire this high-quality mid-cap growth semiconductor company.

Although I wouldn’t call Renesas a prime strategic acquirer of IDT, I can see how the company’s capabilities in auto sensors, power management, and wireless power would hold a lot of appeal, not to mention the strong growth outlook for IDT in other markets like memory interfaces, industrial sensors, and wireless charging. Assuming a normal level of post-deal cost savings, I believe Renesas could pay something in the low-to-mid $40s for IDT and still reap worthwhile (double-digit) long-term returns on the deal.

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Renesas And IDT - It May Or May Not Be True, But It Makes Some Sense

Infineon Facing Near-Term Ordering Risks, But Attractive Long-Term Growth Opportunities

These are interesting times for the semiconductor industry. End-market demand is still pretty healthy, and with many suppliers at or near capacity, lead times have lengthened and double-ordering has become more commonplace. That's a threat to companies like Infineon (OTCQX:IFNNY) (IFXGn.XE), ON Semiconductor (ON), and STMicroelectronics (STM), as the industry has struggled in the past to exit gracefully from periods of extended lead times and deal with what is often an over-capacity situation in the immediate aftermath.

I do believe the near-term outlook for Infineon has some risks to it (and I would say the same for ON, STM, and Renesas (OTCPK:RNECY)), but I like the company's long-term growth opportunities in areas like auto, factory automation, renewables, and appliances, as it leverages its very strong position in power and looks to grow share in microcontrollers (or MCUs).

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Infineon Facing Near-Term Ordering Risks, But Attractive Long-Term Growth Opportunities

Volatility And A Murky Near-Term Outlook Hammer Renesas Electronics

I had previously said that I thought this year could be a little shaky for Japan’s Renesas Electronics (OTCPK:RNECY) (6723.T), the global leader in microcontrollers (or MCUs) and one of the leaders in semiconductors for autos, but I didn’t expect the sharp declines in the stock since July, nor the significant underperformance to peers like ON Semiconductor (ON), Infineon (OTCQX:IFNNY), or STMicroelectronics (STM) in what has admittedly been a weakening market for many chip companies.

Between inventory corrections in the auto channel, a much weaker outlook for industrial automation in China, and less near-term leverage to strong auto segments, the next few quarters could still be rough for Renesas. The long-term outlook remains favorable for the company, though, and the market seems to be pricing in an ugly correction. It may take a little while for this stock to shake off these worries, but the potential value makes this a name worth watching.

Readers should note that Renesas’s ADRs are not particularly liquid.

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Volatility And A Murky Near-Term Outlook Hammer Renesas Electronics

Lead Times Are A Risk, But ON Semiconductor Seems Undervalued

Can I really complain about the performance of ON Semiconductor (ON) over the past three months or on year-to-date basis when the shares are up 50% over the past year and have thumped not only the SOX, but peers like Texas Instruments (TXN), Infineon (OTCQX:IFNNY), and STMicrolectronics (STM)? Even so, these shares haven’t done so well lately, and I believe that’s largely due to concerns that rising lead times are signaling some weak orders and weaker revenue in the not-so-distant future.

Maybe this time will be different and the industry will navigate back to more normal lead times without major order/revenue disruptions. I don’t like to count on “maybe it will be different”, though, and the awful performance of Renesas (OTCPK:RNECY) highlights how unforgiving the market can be when companies go through an “adjustment phase”. ON Semiconductor shares do look undervalued and I do like the company’s long-term position in markets like auto and industrial and parts of communications and computing, but the risk of near-term turbulence is something to consider if you’re the type of investor who hates short-term pain in the pursuit of long-term gain.

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Lead Times Are A Risk, But ON Semiconductor Seems Undervalued

Short-Term Pain, But Long-Term Upside, At Renesas Electronics

In the month since I last wrote about Renesas Electronics (OTCPK:RNECY)(6723.T) the shares had been doing pretty well relative to the overall semiconductor space and peers/comps like Texas Instruments (TXN), Infineon (OTCQX:IFNNY), and STMicroelectronics (STM). Unfortunately, Renesas announced that there would be further inventory corrections in the second quarter related to product transitions that would pressure gross margin, and management didn’t explain it particularly well.

While the market for microcontrollers in general, and particularly those used in advanced automotive applications, is going to be intensely competitive, I believe Renesas’s share price still undervalues the opportunity. The company has strong share across its addressed markets, has been increasing R&D and trimming SG&A, and has shown that it can integrate large acquisitions. While longer lead times across the chip sector are a threat, and Renesas may be pressured by weaker comps in auto in 2018, the longer-term outlook is still quite attractive.

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Short-Term Pain, But Long-Term Upside, At Renesas Electronics

ON Semiconductor Performing Well As The Cycle Ages

Like a lot of chip companies, ON Semiconductor (ON) has seen its share price slide over the last few months as investors have become more worried about lengthening lead times and the prospect that the cycle is peaking. I wouldn’t advise ignoring that risk (it’s really never different this time, and semiconductor demand is still cyclical), but ON’s leverage to growth opportunities in auto and industrial end-markets and ongoing synergies from the Fairchild deal can still support a worthwhile outlook. I’d also note that expectations aren’t exactly robust – mid single-digit free cash flow growth would be enough to support a higher share price.

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ON Semiconductor Performing Well As The Cycle Ages