Who will survive the semiconductor upheaval?

The semiconductor industry has been in a state of flux for years. Over the decades, its supply chain has slowly moved away from mammoth sites in the US, to thousands of foundries that span the Asian continent. It has developed into one of the most intricate, complex and political arms of the global modern economy. It has also completely messed up. 

Various multi-speed economic recoveries have confounded the industry’s original outlook for demand this year. Last spring, the chip manufacturers scaled back production plans, taking their cue from the automotive industry’s huge cuts in sale forecasts. 

But a recovery in China since the summer has given an unexpected boost to demand for chips. In the West, too, appetite for consumer electronics is still going strong: Apple (US:AAPL) logged a record $65.6bn (£47.5bn) iPhone sales in its latest quarter. 

This is not what chip suppliers had expected. Now they are struggling to keep up: lead times at factories are getting longer – over the past year, 11 per cent of all semiconductor components took 10 more weeks to make, according to IHS Markit. 

The global chip shortage is hurting manufacturers across the market. Renault anticipates that it could make 100,000 fewer vehicles this year. Meanwhile Samsung Electronics (KR:005930) has warned that it may have to delay the annual launch of a new Galaxy smartphone, in a first since 2009. 

Operationally, this is a nightmare. But strong demand and limited supply means that some investors are flocking to semiconductor stocks.

Caution is still warranted – not every supplier is taking off. In the UK, IQE (IQE) shares slumped 15 per cent on the day of its 2020 results, even after it said that it grew revenue by more than a quarter year-on-year, narrowing its operating loss to £5.5m from £18.8m in 2019. 

The company, whose chip wafers are used in handset devices and telecom infrastructure, looks like it is finally starting to reap the benefits of the 5G mega-cycle. But the market is still hung up on its low profitability compared with peers; IQE revealed that its gross margin sits at 18.7 per cent, compared with rival ranges of 25 to 50 per cent. 

Moving parts

On a global scale, Taiwan Semiconductor Manufacturing Company (TPE:2330) is the clear outperformer. The behemoth accounts for more than half of the industry’s total output, with its closest competitor, Samsung, trailing behind at 17 per cent. 

The shortage is drawing more attention to its technological and financial dominance in the market. TSMC’s home territory of Taiwan is also under threat of invasion – or asymmetrical warfare – by China, so tech cold war watchers are already eyeing the chipmaker closely. 

Stateside, President Biden is pushing for $37bn (£27bn) in funding for legislation to support domestic chip manufacturing, in an attempt to rebuild the nation’s status as a semiconductor powerhouse. The shadow of Intel (US:INTC) looms: but here, too, the American dream is holding out hope. Last week it announced it would spend $20bn to build two new chip factories (or ‘fabs’) in Arizona, in the next step of its ambitious turnaround strategy. 

The tech giant’s new chief executive Pat Gelsinger is, unsurprisingly, optimistic that his company can step up to the plate as global chip supplies are squeezed. “We’re just trading at multiples well below the industry because people were uncertain,” he said in an interview with Bloomberg. “The market needs more semiconductors, Intel is going to step into that in a big way.” 

But Intel’s plan to build most of its own chips goes against the advice of activist investor Daniel Loeb, whose hedge fund owns a $1bn stake in the company, to withdraw from manufacturing. The company still has to outsource its most advanced chips to its competition, TSMC and Samsung. True, it has plans to ramp up its capital expenditure by around 30 per cent to somewhere between $19bn and $20bn this year – but that is still going up against TSMC’s guided range of $25bn to $28bn. Catching up will be a long slog. 

A perfect storm

The current blockage to the Suez Canal is likely to add to the pressures on the global chip supply chain, on top of the impact of factory fires in Japan and winter storms in Texas in the past few months. Analysts at Bain & Company think that a sustainable fix to the shortage could take 1 to 3 years. In the meantime, it looks like the strong (read: TSMC) will only get stronger, hoovering up excess demand with its huge capacity power.