This week, a number of high-profile semiconductor companies confirmed that consumer electronics spending is hitting a rough patch. Nvidia (NVDA 4.28%) said that PC and laptop demand is hurting its video game segment, and Micron Technology (MU 4.37%) said PC and smartphone sales are going to be sharply lower in the second half of 2022 as device manufacturers work through built-up inventory of some components.
The market already knew trouble was brewing. Semiconductor stocks have declined 25% so far in 2022, as measured by the iShares Semiconductor ETF (SOXX 2.93%). However, in spite of a deafening chorus lamenting the onset of a cyclical downturn in the chip industry, this ETF has rallied sharply off highs. The reason? Though consumer spending is hitting the skids, enterprise spending on chips for the cloud, data centers, artificial intelligence (AI), and the like is still going strong.
Three Fool.com contributors think chip stocks are a buy right now for the long haul. Here’s why Nvidia, Micron Technology, and Kulicke and Soffa Industries (KLIC 2.60%) top their buy lists right now.
Familiar territory for Nvidia shareholders
Nicholas Rossolillo (Nvidia): For longtime owners of Nvidia, this week’s announcement by CEO Jensen Huang and company feels like 2018 redux. The chip industry overall is slowing after a run of strong growth. There are demand issues in China. The cryptocurrency market (parts of which use GPUs like what Nvidia designs to “mine” crypto) has just taken a brutal beating. And Nvidia is preparing to announce a new generation of gaming GPUs later this autumn (which means some gamers might be delaying purchases until the new hardware comes out). As a result, Nvidia said its preliminary gaming segment sales declined 33% year over year in Q2 fiscal 2023.
The high-end video gaming graphics company has always been pretty cyclical. Nvidia releases new GPUs that can handle more powerful video games, gamers upgrade laptops and PCs, sales boom then ebb, Nvidia announces another GPU refresh, and the cycle repeats. While the 2022 downturn has its unique challenges, this is familiar territory for longtime shareholders.
One key difference this time, though, is that Nvidia is now a diversified business. In fact, based on its preliminary Q2 numbers, Nvidia’s data center business (where it’s powering AI and other high-performance computing for enterprises) grew 61% year over year. With sales of $3.81 billion, data centers are now Nvidia’s largest segment at an implied 57% of total revenue.
At some point, the data center end-market will also go through a slowdown or cyclical downturn. But Nvidia now has lots of irons in the fire (a cloud software licensing business, automotive and industrial equipment chips, new gaming chips). When Nvidia and the chip industry hit these bumps in the road, I start buying through the downturn while awaiting the next cycle higher. At this juncture, I see no reason to treat this top semiconductor stock any differently from times past.
This advanced packaging leader is incredibly cheap
Billy Duberstein (Kulicke and Soffa): One way to play the chip sector is semiconductor equipment stocks, the “picks and shovels” to the industry. When people think of semi-cap equipment, they usually turn to front-end equipment-makers, which print massive numbers of tiny transistors onto silicon chips. However, investors shouldn’t overlook advanced packaging companies.
That’s because front-end scaling is now bumping up against the laws of physics. In response, the chip industry is applying more advanced packaging techniques to continue generating more power with less energy. By bringing chips, memory, and accelerators closer together and connecting them more efficiently within devices, packaging can continue improving total system performance.
Many leading chipmakers have even begun designing “chiplets,” or smaller semiconductor units that perform specific functions, which can be rearranged with other chiplets to make customized “super-chips.”
Kulicke and Soffa stands to benefit handsomely from this trend, as a leader in traditional wire bonding, and in more modern advanced packaging techniques for general semiconductors, automobiles, and advanced displays.
K&S’ workhorse product is the wire bonder, a legacy bonding product for which it has more than 60% market share, according to VLSI Research. However, since CEO Fusen Chen took over the top job in 2016, K&S has done an excellent job of developing new products in advanced packaging, such as thermocompression bonding, and a new product line in mini/microLED assembly, both through internal R&D and tuck-in acquisitions.
On the recent conference call, Chen noted its newer advanced packaging technology products were tracking 35% ahead of expectations given at the company’s Investor Day one year ago.
The advanced display segment also offers lots of potential. MiniLED is a cutting-edge display technology, offering deeper blacks and richer colors, and is replacing OLED in many products such as high-end TVs. Apple (AAPL 2.14%) is beginning to incorporate miniLED into more of its products. The new Pro versions of MacBooks and iPads will feature miniLEDs.
K&S is a notoriously cyclical stock, and we are definitely entering a near-term downturn. Widespread pullbacks in industry expansions caused management to guide for a sequential 25% decline in revenues next quarter, and for earnings per share to fall more than 50%, from $1.99 last quarter to $0.93 in the upcoming quarter.
So why is the stock a buy? Because it’s really cheap! K&S now trades in the mid-$40 range, and also has a strong net cash position of about $12.50 per share. Even taking next quarter’s earnings per share as a baseline, that would equate to $3.60 per share in a downturn. If that marks a cycle’s bottom, that means the stock trades at less than 10 times trough earnings, stripping out its excess cash. Meanwhile, over the past 12-month “boom,” K&S earned $8.06 per share.
Even if near-term revenue and earnings fall lower, the growth in packaging intensity should allow for bigger highs and lows over time. Meanwhile, Chen noted that by 2024, many new advanced packaging and miniLED products just being qualified today will be hitting the markets. I’d suspect K&S will still be profitable through a downcycle, and eventually make higher highs than even the 2021 “boom year” at some point. Then today’s stock price will look like even more of a bargain.
Temporary sales slowdown, temporary stock discounts, audacious long-term plans
Anders Bylund (Micron Technology): Memory chip specialist Micron Technology almost always seems to be on fire sale. The stock rarely trades above 10 times trailing earnings, apart from a two-year surge above that line in 2020 and 2021.
2022’s inflation concerns ended that hot streak, pushing Micron’s price-to-earnings ratio below 7 again. The latest twist in that chart was a 3.5% haircut on Tuesday, inspired by Micron’s lowered fourth-quarter guidance. Customer demand for memory chips has cooled due to supply chain challenges and macroeconomic issues. Many companies that build devices containing digital memory chips are digging into their warehouse inventories rather than ordering new stock at the moment.
Micron is managing its expected near-term revenue slowdown by holding back on chip-making equipment installations over the next couple of quarters. However, I think it’s a mistake to focus too much on this temporary issue, which undoubtedly will leave Micron with an explosive amount of pent-up demand and another sharp revenue spike in 2023 or 2024.
On the same day as that chilling guidance cut, Micron also committed to investing $40 billion in U.S. memory-chip manufacturing facilities before 2030. This plan is supported by the freshly signed Chips and Science Act, a government bill that includes $52 billion of funding for U.S. chip designers and semiconductor manufacturers.
So Micron will more than double its chip-making assets over the next seven years, creating roughly 40,000 jobs for Americans and a massive source of memory chip supplies. Today, most memory chips are made in Taiwan, China, or Japan. In light of the economywide supply chain problems that started with semiconductor shortages in Asia, Micron’s domestic investment might be considered a matter of national security.
You can invest in Micron’s sensible and patriotic long-term plans for the bargain-bin price of just seven times the company’s trailing earnings. I’m not concerned about the short-term revenue downturn, because Micron has a robust balance sheet and fantastic long-term plans.
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