Reputations die hard, and STMicroelectronics' (NYSE:STM) ("STMicro") reputation as a lackluster, relatively undifferentiated, semiconductor (and worse, a French semiconductor company) has continued long past its point of relevance. STMicro is poised for continued leadership in high-end power (autos and industrial) and 32-bit MCUs, as well as more emerging markets like GaN-based RF devices and IoT, and has designed its way into meaningful content with Apple (AAPL).
It's a better company than it has ever been in the past, and on a trajectory for $22.5B-plus revenue with 30%-plus operating margin, but the valuation doesn't always reflect it. Even so, the shares are up about 15% since my last update, beating the semiconductor index (the SOX) by a comfortable margin, though occasionally lagging at times over the past year.
This next year isn't going to be all beer and Skittles. There are legitimate concerns about end markets like industrial, communications, and consumer, and although EV-related chip supply is still tight, high lead times generally make me nervous. Even so, I continue to believe in an outlook that includes 7% long-term revenue growth (driven in large part by auto and industrial electrification) and mid-teens FCF growth, and I believe these shares still offer an attractive long-term return.
In the rock-papers-scissors world of relative performance, STMicro's fourth quarter results may not have been exceptional in their own right, but they were quite good relative to expectations and the few companies that have reported so far, and likewise with guidance for Q1'2023.
Revenue rose 24% year over year and a little more than 2% quarter over quarter, more or less meeting expectations for the quarter. By segment, Automotive & Discrete (or ADG) reported 38% yoy and 8.5% qoq growth, beating by about 3%, Analog MEMS & Sensor (or AMS) reported7% yoy growth and 3% qoq contraction, missing by 4%, and Microcontrollers & Digital ICs (or MDG) reported 29% yoy and slight qoq growth, beating by 2%.
Gross margin improved 230bp yoy and weakened 20bp qoq to 47.5%, beating by 40bp. Operating income rose 45% yoy and about 1% qoq, beating by 3%, with a margin up 420bp yoy and down 30bp qoq to 29.1%.
By segment, ADG posted 118% profit growth (margin up 1010bp to 27.7%), beating by 16%, AMS posted about 2% growth (margin down 120bp to 25.8%), missing by 3%, and MDG posted 57% profit growth (margin up 630bp to 35.8%), beating by 8%.
So far, both Texas Instruments (TXN) and NXP Semiconductors (NXPI) have reported. Texas Instruments posted a 3% yoy and 11% qoq revenue decline, while NXP posted 9% yoy growth and a 4% qoq decline. While STMicro's first quarter guidance was almost 8% above the sell-side estimate and equated to a 5% qoq decline, Texas Instruments guided to a 7% decline and NXP to a 9% decline.
While the consumer electronics market (including PCs and smartphones) has gotten a lot of attention, and sometimes STMicro trades like just another Apple supplier), this market doesn't concern me too much in 2023. I do expect a mid-single-digit decline in global smartphone unit volumes in 2023 (and likely higher for Apple), but consumer devices and smartphones are only about 15% of STMicro's overall mix.
At around 40% of revenue exposure, STMicro's industrial exposure concerns me more, as I expect to see weaker demand across a range of end-markets for motors, automation, IoT, and other products using microcontrollers, power devices, sensors and the like. MCU lead times have started to crack noticeably, and given what auto companies are saying, I doubt auto MCU lead times have shrunk all that much, leading me to believe that it's industrial MCU demand that's starting to fade. That said, management was pretty bullish in its commentary, pointing to a healthy backlog and demand.
Stay tuned for earnings reports from companies like Honeywell (HON), Eaton (ETN), Emerson (EMR), Siemens (OTCPK:SIEGY) and the like; Rockwell's (ROK) December quarter was better than expected, with a healthy growth outlook, but there is evidence of a real slowdown in shorter-cycle demand. Other companies with meaningful industrial exposure include Analog Devices (ADI), Microchip (MCHP), onsemi (ON), and Texas Instruments.
I'm relatively bullish on STMicro's auto exposure in 2023 (more than a third of revenue). While I expect healthy overall trends for auto production as OEMs look to replenish inventories (good for STMicro's auto MCU business), I expect better than 50% growth in EVs, and STMicro has meaningful leverage to advanced power devices here. For similar reasons, I think Infineon (OTCQX:IFNNY), onsemi, NXP, and Renesas (OTCPK:RNECY) can look forward to healthier auto end-market activity in 2023, though NXPI lacks the high-end power exposure (while STMicro lacks much exposure to battery management and ADAS).
Other markets, including data center and wired/wireless communications, aren't that material to STMicro, though the company has logged some wins in satellite, optical, and wireless infrastructure and the company's GaN business is a long-term potential source of growth.
Competition is going to heat up from here in the silicon carbide (or SiC) space, with STMicro, Infineon, onsemi, Wolfspeed (WOLF) and others all targeting this attractive multiyear growth market. While the most attractive growth opportunities are arguably in high-voltage auto power (for EVs), I wouldn't sleep on opportunities from industrial electrification (automation, robotics, et al), renewables, and power infrastructure (micro-grids and so on).
The one downside to this large addressable market, apart from competition, is the substantial capital that STMicro will have to invest to hit its target of 40% insourcing. I believe this will prove to be money well-spent, but the reality is that the upfront costs are certain and the long-term market share, revenue, and margins are not. Still, STMicro has done a good job of meeting or exceeding its SiC growth goals, and the new target of $1B-plus in 2023 revenue seems achievable to me.
STMicro is looking for a soft landing with MCU pricing and given the demand/supply imbalance, and the lack of new capacity coming online for 28nm and older nodes, I think that's not an unreasonable assumption. I do expect demand to hold up better in auto MCUs (and STMicro has logged some new wins with Stellantis (STLA) and Volkswagen (OTCPK:VWAGY)), but I do see some risk in the industrial MCU business over the next 6 to 12 months.
An industrial slowdown will take STMicro's growth below my expected long-term trend line for a couple of years, but I do think 7% long-term revenue growth is achievable, as well as 30%-plus operating margins and mid-teens free cash flow margins. With my discounted cash flow model, this supports a near-term fair value in the low-$50s and a long-term annualized potential total return above 10%.
I likewise see STMicro as undervalued on margin-driven multiples (EV/revenue and EV/EBITDA). While these multiples can over- and under-shoot during cyclical peaks and troughs, they still work reasonably well and based on a gross margin of almost 47% in FY'23 and an operating margin of around 26.5%, I believe the shares are undervalued below the mid-$60s.
STMicro shares have popped this year, and I can understand wanting to wait in the hopes of a pullback. Getting these shares below $40 would be a solid opportunity, no doubt, but given that I see respectable potential from today's price, I wouldn't favor getting too fancy about market timing. I do believe STMicro will be one of the winners from widespread electrification and automation, and I think today's price offers a solid, if not perfect, entry price.
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