Sage Investment Club

Michael Vi We remain convinced that the semiconductor industry is an excellent long-term investment opportunity for retail value investors. Seeking Alpha posted more than a few of our articles about companies in the electronics and semiconductor sectors. We are moderately bullish on NXP Semiconductors N.V. (NASDAQ:NXPI) at this time. It is profitable, enjoys good free cash flow, and has manageable debt. It uses the debt wisely to develop new designs and products for every electronics sector. However, there are conditions stifling the industry that worries us. Shortages may not be over and competition is fierce. Worth the Price The stock is expensive for small investors (~$158 per share) but has momentum. Wall Street analysts give it a Buy rating. All through 2022, SA authors wrote beamishly about the stock showering it with bullish ratings. SA’s Quant Rating is a Strong Buy. The rating is supported by healthy Factor Grades save for the current valuation. Quant Rating & Factor Grades (Seeking Alpha) The current Quant Rating is remarkable since it has a D for valuation. We are expecting the industry to have a down year. The consensus among analysts is for a 3.6% to 4.1% drop in semiconductor market growth this year. NXP shares tumbled 30.4% over the last 12 months in line with the 33% drop in the NASDAQ Composite Index (COMP.IND). NXPI is down from a $175 per share price high just 5 weeks ago. It may not be that consumer demand is lower. An SA industry analyst’s assessment is: Total market size expected to be $580B in 2022 and $557B in 2023. Memory segment is expected to fall 17% to $112B in 2023. Optoelectronics, Sensors, Discrete and Analog expected to have single digit growth. All regions are expected to remain flat in 2023; Asia-Pacific expected to fall 7.5%. The lowered forecast for growth is due to inflation and lowered market demand. It might not be that consumer demand is lower, as much as inventories of electronic devices are spotty to vacant and they are waiting for sales. The good news for the semiconductor industry and investors is that modern electronics depend on semiconductors to enable communications, computing, and medical devices; defense weapons, transportation, and energy delivery cannot work without them. Company Growth and Challenges NXP Semiconductors is an Integrated Device Manufacturer that designs, manufactures, and markets its microprocessors, memory chips, commodity integrated circuits, and complex “systems on a chip.” The company market cap is ~$41B. Yet, it is not among the top ten generators of revenue in the industry. The 17-year-old company went public in 2010. NXP was a spin off by Koninklijke Philips N.V. (NYSE:PHG). NXP went on to acquire 5 other companies but most of its revenue growth is organic. The stock price increased 464% over 10 years and about 34% over the last 5. Shares hit a 52-week high of $232.36 after a 2021 low of $132. NXP sectors are 80% semiconductors and 20% IT products and software for automotive, industrial and Internet of Things; they are used in mobile, retail, and communication infrastructure applications. The company carved niches in smart homes and smart city technologies. It operates in 30 countries. In January ’23, the company announced its new i.MAX 95 application processors. The i.MAX 95 is an accelerator for machine learning and high-speed data processing. The technology enables advanced applications in automotive, industrial, networking, connectivity, advanced human-machine interface (HMI), and more. SA shared what the CEO of NXP recently told investors; i.e., to expect “weakness and softness” in the consumer mobile market. He expects “strong resilience” in automotive and industrial markets. The company products are “sold out,” and orders placed this year will not be delivered “for the next full calendar year.” We anticipate the supply gaps will continue well into 2023 and 2024. Moreover, the rising pricing for wafers might suppress demand for consumer electronics more than what is occurring especially if large numbers of workers cannot find jobs. Supply and Demand Governments are investing in the industry and have controlling interests in some. A hallmark of the Biden administration’s platform is building a thriving domestic semiconductor industry. Chips are poised to be a trillion-dollar industry by 2030, according to McKinsey & Co. Other challenges facing the industry that we have noted: higher costs are cause for higher semiconductor prices with inflation worming into end-user products prices COVID-19 outbreaks keep slowing manufacturing operations resulting in less supply lack of skilled workers contributes to the shortages; the world is going to need another million talented people to meet rising demand massive consumer spending post-pandemic depleted semiconductor inventories that cannot be replenished fast enough competition for raw materials is challenging insufficient foundry space hampers rebuilding semiconductor inventories Consumer demand thru & post pandemic (Jabil) Demand for semiconductors is voracious. A Samsung Electronics Co (OTCPK:SSNLF) executive declares, “we’re in a chip war.” NXP, heavy into the automotive sector, is facing more competition. QUALCOMM (QCOM) entered the automotive market important to NXP’s growth. Auto manufacturers are transitioning from combustible engines to EVs. Enter behemoth QUALCOMM to the automotive sector with its $125B market cap and Snapdragon Digital Chassis product; it provides assisted and autonomous driving tech, in-car infotainment, and cloud connectivity that increased its automotive business to $30B. In the past, China squashed a buyout of NXP by QUALCOMM. Tailwinds for NXP In October 2021, NXP informed the public that the companies are cooperating on selling into the electronic wearables market, and “are expanding their collaboration to now also integrate NXP’s eSIM solutions to wearable devices based on QUALCOMM’s widely adopted Snapdragon Wear platform.” There is plenty of room for chip makers in the automotive market because it is expanding globally faster than most other economic sectors. NXP, second, is designing new devices and expanding its portfolio. NXP wants to get its products into the hands of manufacturers faster so they can bring their products to market sooner. Automotives drive the semiconductor industry (McKinsey & Company) Third, NXP revenues increased despite tough conditions. In 2020, total revenue was $8.6B, and +$11B for FY ’21. In the first 3 quarters of 2022, total revenue topped $9.88B. Earnings before tax and net income increased in each of the FY ’22 three quarters. The company actually beat earnings estimates in Q4 ’21 and in every subsequent quarter. Last year’s Q4 EPS was $3.20. We expect Q4 ’22 EPS to be about $3.65. Hedge funds bought more shares throughout 2022 increasing their holdings by 317K shares last quarter. Corporate insiders sold 55.5K shares in 12 months while buying 66.5K. The next earnings report is scheduled for January 30, 2023. An additional reason to be bullish is the healthy balance sheet. As of October, ’22, NXP Semiconductors had $11.2B of debt; it increased by about $1.6B Y/Y. We believe management uses debt wisely. Management increased spending on R&D and SG&A in each of these 3 quarters. The debt is offset by $3.76B in cash and equivalents. Short interest is slightly above 2% as is the dividend yield (2.14%). The dividend is safe, has regularly grown over the years, and is paid consistently. Balance sheet & cash flow charts (YCharts) Takeaway Semiconductors are the brains of electronic devices. The industry is essential to the growth and safety of modern societies. They operate everything from transportation to medical devices, weapons and farm tractors, and more. NXP Semiconductors increased revenues through acquisitions but primarily through organic growth. The company is profitable. Its debt is used wisely and it manages to produce excellent free cash flow. It has more growth potential and little risk , though the share price has a high valuation. A deep and long global recession as some predict will pound the price. We forecast another year or longer before solutions to the above challenges slake the chip shortages. Revenue and earnings are likely to be down. Adding to our sense for caution about NXPI is the 1.22 Beta rating; that indicates the shares of NXP are more volatile than the general market. It will take years for manufacturers to build out enough capacity to fulfill demand. We find the joint projects between QUALCOMM and NXP intriguing. Conditions are encouraging strategic partnerships. Government regulatory stringency quashed M&As in the industry for the last 2 years, from 90 deals in 2018 to 38 in 2022. Old flames die hard and new partnerships sometimes lead to marriage.

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