To Infineon and beyond

Infineon (DE:IFX) is a German chip manufacturer that specialises in the ‘power semiconductors’ that manage the flow of electric current through devices. It is one of the world’s top 10 semiconductor companies, with its chips spanning four broad applications – automotive, industrial, consumer electronics and security solutions.

Hailing semiconductors as the “building blocks of modern society”, management has positioned Infineon as both an enabler and a beneficiary of several ‘megatrends’ that are likely to play out over the coming decades. These include the electrification of transport, the switch to 5G mobile telecoms and the shift towards the much-vaunted ‘Internet of things’ (IoT). Infineon is also an important player in the green energy transition, supplying semiconductors to major wind-turbine and solar-inverter makers, such as Vestas (DK:VWS) and Siemens Gamesa (ES:SGRE).

An electric future

More than two-fifths of Infineon’s revenue comes from the automotive market where semiconductors are essential components for everything from a car’s electric power steering to deploying its airbags. With automakers adding features such as ‘advanced driver assistance systems’ (ADAS) – which are increasingly mandated by regulation – more and more chips are required for the modern-day car.

Thanks to the €8.3bn (£7.2bn) acquisition of US semiconductor maker Cypress last April, Infineon is now the world’s top automotive semiconductor marker with a 13 per cent market share. Rather than selling to carmakers directly, it deals with ‘tier 1’ suppliers such as Bosch (US:BOSCHLTD) and Continental (DE:CON).

The auto industry is cyclical, but some of the fluctuation in demand should be smoothed out by the long-term structural shift from the internal combustion engine to electric vehicles (EVs). Infineon estimates that there is on average $834 (£599)of semiconductor content per EV, versus $434 per carbon-powered vehicle. Further down the road, management reckons that a fully autonomous vehicle could require as much as $1,250-worth of semiconductor material.

The Polar Capital Technology Trust (PCT) has homed in on Infineon as a way of tapping into the rise of EVs. “We think semiconductors are one of the best ways to play the EV space,” says analyst Paul Johnson. “The number one power semiconductor player in the world is Infineon, and they’ve really been benefiting from the near-term supply and demand trends, in particular, the recent acceleration of EV adoption in Europe and China.”

Indeed, momentum in Europe plus a bounce back in China following a cut to subsidies helped grow global EV sales by 43 per cent in 2020. On the back of new EV models being launched and a supportive policy backdrop, broker Liberum estimates that there will be a further 47 per cent growth this year.

Infineon doesn’t supply chips for market leader Tesla (US:TSLA), but its semiconductors are being used by other EV makers, leaving it well positioned as EV market competition heats up. Mr Johnson points to the group having “significant content in several EV models that are beginning to ramp up, including the VW ID.3, which has become one of Europe's best-selling EVs”. Infineon’s semiconductors have also been adopted by popular Chinese EV makers such as Nio (US:NIO).

Global chip shortage spells good news

The global automotive industry has recently been hit by a semiconductor shortage, forcing several carmakers – from Volkswagen (DE:VOW3) to Nissan (JP:7201) – to curtail their manufacturing activities. Ford (US:F) warned earlier this month that it could lose as much as a fifth of its first-quarter production due to the lack of chips.

Automakers typically order semiconductors six to nine months in advance, meaning that chips due for delivery from December onwards would have to have been requested at the height of the pandemic. But carmakers underestimated the rebound in demand and chipmakers are now unable to scale up production at short notice as much of their capacity has been diverted to meeting the Covid clamour for consumer electronics, such as laptops and games consoles.         

“That's beneficial for the likes of Infineon and STMicroelectronics (FR:STM) because it means that their 'fabs' (factories) are going to be fully utilised and they’re going to be able to get better pricing as well,” says Johnson. Indeed, the March quarter is usually the period when carmakers negotiate lower prices, but with demand currently outstripping supply, the chipmakers have more pricing power this year.

High demand for EV semiconductors saw Infineon’s automotive revenue rise by a tenth year on year in the three months to 31 December, to €1.2bn, with the book-to-bill ratio – confirmed orders as a proportion of revenue – hitting 1.5.

The division’s adjusted operating profit margin is typically lower than for Infineon’s other business lines (see chart) as EV sales are still low relative to heavy investment in research and development. But with utilisation of the group’s fabs hitting mid-90 per cent  in the December quarter, the margin came in at 16.1 per cent, up from 7.9 per cent a year earlier.

The bottleneck is expected to continue for at least a few more months and, with fab utilisation set to remain high, Deutsche Bank is forecasting that the automotive margin will finish the current financial year at 15.3 per cent. As the group’s facilities in Germany and Austria ramp up production, Deutsche Bank predicts that margins will continue to rise, helping Infineon achieve its medium-term target of a group adjusted operating profit margin of 19 per cent in 2023.

Picking up speed

In light of the improving outlook for the automotive market, Infineon recently raised its profit guidance, pointing to €10.8bn of revenue for the year to 30 September, up from previous expectations of €10.5bn. Analysts have taken a similarly bullish stance and upgraded their forecasts, and there could be more revisions to come. JPMorgan believes that Infineon’s guidance could prove conservative, saying that, as its orders translates into sales, the group could increase its estimates again.

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As a further sign of confidence, Infineon plans to increase its full-year capital expenditure to between €1.5bn and €1.6bn, which will enable the new chip factory in Austria to start production in the September quarter – earlier than planned – and bring extra capacity online.

The Cypress acquisition has stepped up Infineon’s presence in chips for the IoT, although it did swing the group from a net cash position into €4.3bn of net debt (excluding lease liabilities and hybrid capital) at the end of June. But thanks to Infineon’s healthy free cash flow generation, this has since come down to €3.4bn. With management indicating more than €800m of free cash flow for the full year, broker Liberum predicts that net debt will fall to €3.1bn by the September year end, equivalent to just 1.1 times cash profits (Ebitda).

Looking further ahead, additional earnings momentum is likely to come from Infineon’s push into silicon carbide (SiC), the next generation of chip technology which enables greater efficiency and higher power density. STMicroelectronics is currently the leader in SiC automotive chips, having secured Tesla as a customer. But given Infineon’s dominant position among other carmakers, Liberum estimates that, as these other makers switch to SiC, Infineon’s share of the automotive SiC market will rise from 4 per cent in 2021 to 18 per cent by 2025.

Rising tech nationalism

Covid-19 has highlighted the fragility of global supply chains, accelerating countries’ desire for technological sovereignty. Germany’s economy minister, Peter Altmaier, recently suggested that the EU could invest up to €50bn in its own chip industry. Although much of that capital would come from private enterprise, increased state support and stronger demand for local chips would still bode well for Infineon.

There is the threat of China looking to increase its chip self-sufficiency in reaction to trade wars with the US, but this ambition remains some way off yet. “It's hard enough to make a semiconductor that is competitive with Infineon – that will probably take several years,” says Walter Price, manager of the Allianz Global Technology Trust (ATT). “But to achieve the lifetime, quality and reliability will take at least another couple of years on top of that.”

The best is yet to come?

Having been weighed down by the semiconductor downturn of 2018/19, Infineon’s shares have been gathering momentum over the past year, rising by over 60 per cent. That means that they aren’t cheap, currently trading at 28 times consensus 2022 earnings – slightly ahead of peer STM and in line with the PHLX Semiconductor Sector Index, which tracks 30 chip-making companies.  

The semiconductor industry has now moved to an upswing, meaning that a more attractive entry point to buy Infineon's shares could be hard to come by. Even in the event of another downturn, Infineon’s shares should prove more resilient – the group is less exposed to the consumer electronics market than STMicroelectronics and its structural growth drivers are bigger and more established than two years ago, which should help offset some of its cyclical exposure. Benefiting from a multitude of long-term tailwinds, we think the shares are worth paying up for.  

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