Remember the Alamo – buy Texas Instruments

By now the numbers will be familiar to many people. Nikkei reports that Taiwan’s contract chipmakers are set to expand their global market share to 66 per cent of foundry revenue this year. Six new semiconductor foundries are now planned in response to the ongoing semiconductor shortage, with Taiwan Semiconductor Manufacturing Company (TW:2330) to the fore.

Covid-19 laid bare the west’s vulnerability to supply chain disruption across a range of industries. This obviously applies to the provision of semiconductors and it’s difficult to imagine a more critical industrial input. The US and the EU have recently decided to subsidise the development of new chip fabrication facilities, and Washington has persuaded TSMC to open a foundry in the US that will manufacture advanced semiconductors. Still, it will be some time before we witness any meaningful increase in production capacity in the Occident.

All this would have been largely academic were it not for the deteriorating security situation in the Far East. Nancy Pelosi’s junket to Taipei was described by Beijing as “reckless and irresponsible provocation”. So it wouldn’t be unreasonable to assume that the chances of a military incursion have increased somewhat. But even if push didn’t come to shove, China could simply go down the asymmetric route by ramping up trade restrictions. The People’s Republic has already slapped a ban on natural sand exports to Taiwan, a far more telling move than you might expect given the commodity’s centrality to semiconductor production and the construction industry – wafers and concrete.

Taiwan, in common with other regional economies such as Japan and South Korea, is resource-poor, so its economy is certainly exposed to raw material restrictions from its bellicose neighbour to the west. However, it’s a two-way street. China is every bit as dependent on Taiwanese semiconductor production as the US, perhaps even more so regarding the most advanced chips.

It beggars belief that policymakers in the west haven’t taken previous measures to ensure an adequate level of domestic supply given that semiconductors are at the heart of all advanced civilian and military technologies. It’s even harder to believe that production by US semiconductor manufacturers will not, ultimately, increase substantially regardless of the vagaries of the relationship between Taiwan and China. This will be helped along by re-shoring initiatives, increased government subsidies and, above all, the desire to build resilience into supply chains. The recent passage of the Chips Act, which grants up to $52bn (£43bn) in subsidies and tax breaks to US chipmakers, provides a more favourable trading backdrop. So which of the leading US chip manufacturers is well-placed to benefit? Well, you could do worse than run the rule over Texas Instruments (US:TSN), a Dallas-based group that is something of a Methuselah in the industry given its incorporation in 1951.

It manufactures a wide variety of analogue chips that are utilised across a range of industrial sectors. It also outsources its embedded chips to other foundries. This broad-based approach reduces the risk of overconcentration in specific end markets, such as smartphones, thus reducing the impact of cyclical slowdowns.

The automotive sector and various other industrial markets generate around 60 per cent of revenues, a positive factor given that the former industry is still badly underserved, as indicated by the 20 per cent sales growth rate for auto chips during the second quarter. Overall, the group registered a 14 per cent increase in second-quarter revenues to $5.21bn with net earnings up by 19 per cent to $2.29bn. The returns easily trumped consensus forecasts, although original expectations had been tempered by the prolonged Covid-19 lockdowns in China and their knock-on effect on demand there. A series of plant modifications enabling a switch to the production of 300mm semiconductor wafers should reduce waste and the consumption of water and energy, thereby providing further support for operating margins and free cash flow.

Valuations for semiconductor companies were subject to a drubbing at the start of the year and it’s accepted that revenue streams will be patchy by comparison to subscription software services, but demand for semiconductors is being propelled further by the accelerated digital transformation in evidence since the start of the pandemic.

That certainly applies to Texas Instruments, but investors will probably need to stomach further volatility on the Nasdaq. The group trades at $183 a share, which is towards the lower end of the consensus spread at 18 times forecast earnings. The shares drifted steadily lower following a negative technical signal in the third week of January, but 50- and 200-day averages are starting to coalesce even though a price/earnings-to-growth ratio of 2.4 might seem a little frothy for some.