STMicroelectronics: This Chip Company Is A Cheaper And Less Risky Option

Summary

• STMicroelectronics is a well-established tech company, with a reliable business and legitimate growth perspective.
• Its fundamentals look more solid than those of other leaders in the chip or semiconductor manufacturing industry, which have benefited from a robust bull market in the last few years.
• The company is priced for modest growth, so earning beats are likely to happen, an ideal situation for investors.

STMicroelectronics (NYSE:STM) is one of the oldest semiconductor companies. It has been listed as a public company since 1994, but it was founded several years before, in 1987, as a merger between an Italian and a French tech company.

Today, it is still an Italian/French company, although it is formally registered in Amsterdam, Netherlands, with several facilities and research centers located in France (mainly Grenoble, Rousset, and Tours) and Italy (Milan and Catania). Other important STM's centers are located in Malta and Singapore.

Its research activity greatly contributes to the company's main assets, owning around 18,000 patents. Over the years, it has developed proprietary technologies like TSV, BCD, FD-SOI, VIPower, ThELMA and FlightSense, to name a few. These innovating know-hows allow the company to stand out from competitors and provide a buffer that will protect STM's future expansion in its main business areas: ADAS, MEMS, and Imaging Sensors, as well as Microcontrollers.

STMicroelectronics is a promising long-term investment

STM stock hasn't followed a straight growing path since IPO. As we can see from the picture below, the initial successful years (coinciding with the famous internet bubble at the end of the last century) were followed by several disappointing periods of underperformance.

Source: Dividend Channel

The company was not able to successfully deal with the normal cyclicality of its addressable market, especially after the problems experienced by Nokia (NOK) and the huge loss STM suffered from the pro forma bailout of its former main customer. At the peak of its expansion, Nokia controlled almost 40% of the global mobile phone market and bought more than $2B in STM's components a year.

Yet, after years of stagnation, STM managed to get back on track, with a new strategy that allowed it to gain considerable shares of promising and fast-growing markets, like ADAS and IoT, as well as new mobile technologies.

The company's operations are divided into three main areas:

1. Automotive and Power Discrete Group (ADG);
2. Analog, MEMS and Sensors Group (AMS);
3. Microcontrollers and Digital ICs Group (MDG).

Thanks to the continuous growth of each of these divisions, this year, STM managed to reach a record turnover level of $9.7B (+17% YoY), together with an extremely high level of gross margins (around 40%) for a company that produces electrical components. The balance sheet is very healthy, thanks to an impressive growth of its free cash flow, that reached $533M in 2018, with an impressive +73% YoY. It's worth mentioning that STM usually calculates its FCF in a materially different way from the standard practice. Once we recalculate it according to the generally accepted method, its 2018 FCF becomes $585M, or + 80% YoY.

Operating margin increased by 250 basis points to reach 14.5% in 2018, thanks to an improved operating efficiency.

The pictures show how the company performed in the last few years: margins improved and its market share increased, surpassing the addressable market's CAGR by almost 100 bps yearly.

Source: Company reports (Author's elaboration)

	2015(I H)	2016(I H)	2017(I H)	2018(I H)	3 Years CAGR
STM net sales	$3.46B	$3.32B	$3.74B	$4.5B	9,1%
STM AM	$74B	$74B	$84B	$94B	8,3%

Click to enlarge

Source: Company reports (Author's elaboration)

STM is better positioned than other chip companies in a slowing market

The sustainability of the impressive growth that the semiconductors market registered in the past years is giving cause for increasing concern. The end of the cycle seems to be fast approaching, with the global market still growing in 2019, but just by a low single-digit number.

However, the sectors with better perspectives are optoelectronics, sensors, and discretes, which are all products offered by STM.

Management has clear plans to further boost its market share growth this year, by deploying three strategic investments:

1. A new 300 ml wafer facility in Agrate, near Milan, focused on stimulating growth in BCD, IGBT and power technologies.
2. Higher capacity for silicon carbide and increased production of gallium nitride for radio frequency devices. It's worth mentioning that STM's early investments already resulted in over $100 million in silicon carbide revenues in 2018 and, as CEO Jean-Marc Chery outlined during the last conference call, the company has numerous projects with many players around the world, such as its recent partnership with Cree (CREE).
3. The company aims at investing in the next generation of imaging sensor technologies, in order to solidify STM's leadership in personal electronics technologies and to meet future demand in selected industrial and automotive applications.

Let's consider buying options other than STM, like, for example, NVDA Corporation (NVDA), Advanced Micro Devices (AMD) or Analog Devices (ADI). Those companies are actually priced for a strong growth in the years to come, whereas STM valuation is much more "conservative".

I reported a quantitative comparison between STM and some of its equals in the table below: I considered just a couple of metrics, namely price to sales and price to book value.

As far as book value is concerned, I compared the intangibles assets that each company is currently accounting for, with its 5-year R&D expenses and adjusted the figures accordingly.

Aside from NVDA, AMD and ADI, the other companies used for the comparison are NXP Semiconductors (NXPI), ON Semiconductors Corp. (ON) and Texas Instruments (TXN).

	Price to Sales Ratio	Price to Book Value (Adjusted)
NVDA	7	5
AMD	3.8	3.6
ADI	6	3.64
NXPI	2.76	2.14
ON	1.5	1.73
TXN	6.1	6.3
Average	4.52	3.73
STM	1.5	1.06

Click to enlarge

STM'S undervaluation is quite evident according to these simple but crucial parameters.

Takeaway for investors

STMicroelectronics managed to change its gloomy fate a couple of years ago and partially reinvented itself as an ADAS systems provider while improving the efficiency of its total operations.

The company's stock exchange performance consistently benefited from this successful turnaround. Yet, the present valuations appear at a clear discount compared to the main players populating the global tech market.

Now, with the approaching end of cycle for semiconductors' business, it makes sense to focus on companies with strong fundamentals and a legitimate growth perspective, instead of high growth firms that still have compelling expectations incorporated in their stock prices.

STM is the perfect choice based on this theory. The company looks cheap after the 2018 fourth quarter equity market's correction, with a total cap that exceeds the annual sales by only 50% and a fair estimation of STM shareholders equity that equals its stock price at the time of writing this.

Investors looking for exposure to stocks in semiconductors and chips companies should consider STM right now, while keeping a long-term attitude, given the natural high cyclicality of this market.

Analyst’s Disclosure: I am/we are long STM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[ExST]

It's true the calls are not as fun as they used to be, just because the CEO is now able to articulate meaningful statements. Bozotti had no clue...

[hello rolrod hello]

hi Mr. GIO .. H ope all is well .. glad to see FOLLOERS growing as you continue to be on the right side of trading .. i like your analyzation of STM and will start soon .. keep us all informed .. THANKS

[Gio Danisi]

Kind reader: I hope you enjoy reading.
If you are interested in further information about the companies included in this article, don't forget to "follow" me.
Best Regards

[jd99]

Excellent company - JM Chery has been at the co for years but has only been CEO for a year or so. They analyst calls aren't as fun anymore since Bozotti retired though Chery will still scold people for dumb questions. While MCUs are very competitive they have a fabulous position in 32 bit MCUs and seem to be the go to product these days. Their analogue power business is the up and comer and where they'll invest heavily in the next decade. The reason for the very cheap valuation is the short cycle consumer exposure and especially Apple - the imaging division is best in class but very competitive and Apple of course have a history of dumping key suppliers. Utilisation is maxed out and they have to spend on 300mm expansion to grow which consumes most of their cashflow. Margins are low and they really should merge with Infineon given spending overlaps but they refused last year to discuss anything. For Tesla fans they have been a key technology enabler via Silicon Carbide power parts. Agree STM is a buy for the next few years.

[malc9141]

I could never make head or tail of Bozotti's replies!

[ExST]

The Infineon merger would absolutely make sense. Difficult to execute because the overlaps are significant, especially in Automotive Power. But Infineon is weak where ST is strong i.e. sensors, MCUs and SiC power so there are also great synergies. And, in an industry that is becoming mature, size matters.

[UP & DOWN]

Isn’t the corporate headquarters in Geneva Switzerland ?

[Derf]

@Gio Danisi

Thanks for the article -- you don't see much on SA about STM.

With that said, didn't STM do something about 3 years ago that is a hard warning to potential investors: cut the dividend 40%? That did not seem to hurt their stock price until mid-2018, from whence it dropped ~30%. Now it could sure use the support of the unreduced dividend, if not one that got raised from time to time instead of cut and held flat since.

I collected 16 of the $0.1/qtr/share dividend until it got cut and continue to hold STM for now but am not adding any semi's until they become stupid-cheap, as in 75% down from peak with a meaty dividend yield.

Ciao and gratzie

[malc9141]

Things have changed. They had a tie-up with Erickson which cost them heaps. They somewhat lost the plot for a while, with too much capacity.

But they gradually re-organized and always had important products, eg time-of-flight distance measuring devices, and acceleration/angle/gradient sensors (MEMS).

As shown in article above:
"Automotive and Power Discrete Group (ADG);
Analog, MEMS and Sensors Group (AMS);
Microcontrollers and Digital ICs Group (MDG)"

These are used in cars and phones. iPhone used the angle sensors, which turned the image round as the phone was moved.

They make good routine electronics stuff.

(Sad to say, a Swedish company which had the same know-how but not the fabrication plant, has sold out to the Chinese).

STM is run by Europeans and the Italian and French govt have considerable holdings. And yes, its in Geneva.

(note: the US company APTIV is headquartered in Dublin!!, I think)

[jack2012]

With the relentless price squeeze the auto manufactures' put on suppliers can the ADG group make money ?

[Gio Danisi]

Def,
thank you for commenting. I am not a dividends fan, or a dividend seeker. if you check my articles I rarely speak about dividends paid by companies I follow, I even don't check if a company pays dividends or not.
From my point of view paying dividends is a waste of resources for a company and as a shareholder I am definitely against the practice. I prefer buy-backs or R&D investments with cash in excess.