Semiconductors – Supercycle pt. VIII

Samsung and AMD join the chorus.

• Weak results from Samsung and a profit warning from AMD are more signs that demand is weakening which in the face of all-time highs in capital expenditure could tip the sector into a sharp downturn.
• Samsung reported preliminary Q3 2022 results that missed expectations almost certainly as a result of weakness in semiconductors with revenues of KRW76tn and operating profit of KRW10.8tn.
• This was meaningfully below consensus of KRW78tn and KRW12.1tn respectively.
• At the same time, AMD has warned that its Q3 2022 will also fall short with revenues of around $5.6bn as opposed to the guidance it originally gave of $6.7bn three months ago.
• This has also hit gross margins which will be down 50% as opposed to the 54% it initially expected most likely as a result of paying for fab capacity it booked but has now been forced to cancel.
• AMD is predominantly blaming its client business (PCs) as a result of both demand weakness and inventory reductions across the industry.
• This is precisely the scenario I was expecting back in 2021 (see here) when panicked manufacturers were stocking up on parts for fear of not having enough and the world was emerging from Covid.
• The combination of strong demand and inventory building triggered unprecedented demand contributing to what I termed a “supercycle” but this also means that when it unwinds, it hurts twice as much.
• Furthermore, the sector is currently building new fabs for geopolitical reasons as opposed to economic ones which could further tip the industry further into oversupply.
• I also disagree with the view that the sector is going to bottom and turn next year because there is no evidence to support it.
• For the sector to turn, demand needs to come back and come back substantially because there will be new capacity to soak up.
• This means that the inflation battle needs to have been won with interest rates at least flatlining or falling.
• The problem is that interest rates are not nearly high enough to put a lid on inflation and central banks simply do not have the ability to raise them that far given how much more the system is indebted than it was in the 1970s.
• Hence, it will not be until the entire pandemic has been paid for through inflation that it will begin to subside and normalise.
• This means that the value of money needs to depreciate by around 40% in total which with 10% in 2021 and 15% in 2022 means we are just over halfway there.
• Consequently, 2023 is likely to be another year where inflation remains high, meaning that in 2024 the money supply and the economy could be back in balance, allowing inflation to fall.
• This is when I would expect the sector to bottom and begin to turn upwards but a lot will depend on how much new capacity comes on stream between now and then.
• In this environment, semiconductors is a difficult place to invest but there are some standouts as the spread in valuation across the sector is very wide indeed.
• Hence, I would continue to prefer both MediaTek and Qualcomm who have a reasonable outlook combined with a cheap valuation.
• I also like TSMC and now Samsung which has halved in USD terms but both of these own factories which is arguably not the place to be in a sharp downturn.