SOXX: The Global Semiconductor Shortage Is Not A Buying Opportunity
- Like many others, the global semiconductor industry is facing a severe shortage due to shipping issues, labor shortages, weather, and potentially geopolitical pressures.
- The chip shortage may continue for some time if demand continues to rise and the global freight issues are not cleared.
- This has been overall bullish for the semiconductor industry and has led to slight outperformance in the popular semiconductor ETF SOXX.
- Despite the situation, I do not believe chip demand will rise at the expected pace from 5G and IoT.
- With chip stock valuations at nearly twice last year's levels, it does not seem to be a good time to buy the market.
Increasingly, it seems that shortages are becoming a normal part of life. Over the past year, the world has seen many shortages stemmed from production slowdowns, trade tensions, commodity shortages, weather events, and direct human error. COVID was the trigger for many shortages, but it seems they are now occurring regardless of the pandemic. This has impacted many goods, but it is currently impacting the semiconductor market with alarming force.
Phones, cars, televisions, and virtually all electric items in our society will likely see their prices rise due to the ongoing delays in chip-making. Initially, this was a temporary COVID-driven problem, but the surge in demand last year has exacerbated the shortage into 2021. This has caused Apple (AAPL), Samsung (OTCPK:SSNLF), G.M. (GM), Tesla (TSLA), Microsoft (MSFT), and many others to delay product launches or cut sales outlooks.
The causes of the shortage are many-fold. Most significantly, an increase in lead times from ~12 weeks before 2020 to over 15 weeks today. This appears to be due to raw material shortages in Asia which stem from the ongoing global shipping container shortage and skyrocketing freight rates. Quite frankly, the sensational Suez canal blockage is only the tip of the iceberg compared to the much more impactful freight container shortage. This is also being exacerbated by mounting vessels unable to move into U.S ports due to labor shortages.
Demand for goods, chips, in particular, have also risen as many are stuck at home with little more to do than consume. Considering U.S retail sales are slipping and jobless claims fail to decline, this demand spike may reverse soon, particularly if it continues to cause prices to rise. That said, the bulk of the issues appear to be supply-centric and it seems COVID may have only been the catalyst for what truly is a fragile global supply chain. Indeed, the global supply chain is like a semiconductor, a small dust-sized item can upset the entire framework due to immense interdependencies.
As an additional example, many of these chips are produced in Taiwan - a small country that accounts for nearly two-thirds of the global semiconductor industry. This is a major supply risk factor considering China has been threatening to invade which would certainly upset the critical supply source. As discussed in Micron's recent investor meeting, a localized drought in central Taiwan may soon further upset DRAM production.
Clearly, there are many factors that have aligned against semiconductor production. Overall, there have not been significant changes in the semiconductor ETF (NASDAQ:SOXX). though it has outperformed the Nasdaq 100 slightly in recent months. This is a sign that the situation may have an overall positive impact on semiconductor stocks. Of course, they have sky-high valuations and the overall economic environment remains precarious so it seems to be a good time to take a closer look at the industry.
How Will Semiconductor Stocks Be Impacted?
Most semiconductor stocks have seen a mixed performance from the shortages. On one hand, some are experiencing operational difficulties which are lowering production and sales while others like Micron (MU) are benefiting from higher prices. Indeed, DRAM prices have surged the most of late however there has been a general trend toward higher prices for producers. This has come despite a slowdown in global semiconductor growth. See below:
The overall trend in the industry is toward the "best of the best" chips which can be used in new phones, artificial intelligence, and others. There has been considerable volatility in chip prices in recent years as demand for "normal" computers has declined while demand for higher-end technologies has risen. However, the market is now in a more bullish environment. According to Cisco's CEO (CSCO), the current shortage may continue for "a couple of years" due to another bullish cycle in demand.
Of course, this view is based on the overwhelmingly popular narrative that the "5G boom", "internet-of-things", "A.I" will soon lead to another golden age for the industry. Considering chip sales have been slow for a few years, this "boom" may prove to be yet another overhyped narrative leading investors into overvalued stocks. Yet, the SOXX semiconductor ETF has delivered stellar performance over the past year and has outperformed the Nasdaq 100 (QQQ) over the past six months. See below:
The divergence pattern of SOXX from QQQ is indicative that the chip shortage has boosted the value of chip producers. Like nearly all technology stocks, chip stocks have been flat for the past six weeks, but they're still faring betting than the technology index. The question is, will the shortage actually lead to strong enough earnings to justify valuations?
Concerning Valuations in Chip Makers
While most chip makers have not seen material sales growth since around 2017, their valuations have skyrocketed. There has been a strong growth for the likes of Nvidia (NVDA) and AMD (AMD) due to their strong placement in high-end growth products. However, this has been a period of stagnation, for the "old school" producers like Texas Instruments. Despite this, nearly all of the top stocks in SOXX have seen their price-to-sales valuations skyrocket. See below:
The median valuation growth of this group is a staggering 250%. There have been no significant changes in the industry's profitability so this means these firms are trading for twice (or more) of their historically normal value. SOXX currently has a very high weighted average "P/E" of 36X and a 70 bps dividend yield which is half the level seen a year ago.
Even if profitability rises this year due to the shortage, such an extreme rise would be needed for this valuation to be justified. Additionally, we must remember that semiconductors are economically sensitive as demand for consumer and industrial electronics will likely fade if issues continue. Unlike the consensus, I do not believe 5G nor other new technologies will increase the overall demand for chips since these sales only offset declines in antiquated products. However, there may be a shift toward the likes of Intel (INTC) and peers as they catch up to Nvidia and AMD.
The Bottom Line
Overall, I do not believe the global semiconductor shortage is a sign that investors should purchase these stocks or ETFs like SOXX. While it is true that the shortage will lead to a temporary increase in profitability, it seems unlikely to deliver permanent growth necessary to justify sky-high valuations in the sector. Indeed, it seems the industry's value is propped up by narratives surrounding new technologies that have yet to be translated into significant bottom-line growth.
While high valuations do not mean falling stock prices, the negative liquidity-based catalysts impacting the entire technology sector could impair semiconductors. This includes excessive buying on margin and low cash among many newer retail investors. These risks are described in much more depth in "VGT: There Have Never Been These Many Bearish Catalysts". While chip stocks may see another wave higher as investors buy the "shortage hype", I believe the industry is unlikely to maintain last year's gains. For now, I have a bearish view regarding SOXX and believe its recent outperformance is unlikely to last.
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