The Lato Letter – January 5, 2017 Volume 6, Issue 1

The Lato Letter – January 5, 2017 Volume 6, Issue 1

The Hill is an American political journalism newspaper and website published in Washington, D.C. since 1994.  It is published by Capitol Hill Publishing, which is owned by News Communications, Inc.  Focusing on politics, policy, business and international relations, The Hill is read by the White House and more lawmakers than any other site.

A recent issue had an in depth look at the global semiconductor industry.  It is an interesting view at how the industry has changed and what the future may hold for technology consumers and investors.  Some readers may recognize that the author who happens to be my son-in-law.  Joel is an institutional equity trader focusing on Technology, Media and Telecommunications (TMT) in the Toronto office of Los Angeles based Wedbush Securities.

I hope that you enjoy the article.

 

Semiconductor rally has room to run in 2017

BY JOEL M. KULINA, CONTRIBUTOR – 12/29/16 12:20 PM EST 1

© Getty Images

As our lives become more and more connected to our devices, the semiconductor industry has been an early winner of the more advanced world we live in. The Semiconductor Sector Index (“SOX”) has, hands down, been the best performing sub-sector within global tech in 2016 (plus-40 percent), with expectations that the current rally has more room to run.

The current cycle is truly unlike anything seen before. Growth drivers are coming from end markets, such as the Data Center, automotive technology (autonomous vehicles), artificial intelligence (AI) and the Internet of Things (IoT). Conversely, cycles of past were driven by PCs, smartphones, & communications infrastructure.

SOX has climbed roughly 442 percent since bottoming out in November 2008 and, though the index feels a bit overbought in the near-term, the majority still believe that there remains further room to grow.

The key will be if generalists come around to the idea that semiconductors are a lot less cyclical than in times past. Given new demand drivers, improved management styles also cannot be ignored.

The supplier discipline has kept inventory levels stable and pricing firm. Bulls believe that continued capacity reductions and supplier discipline will lead to increased pricing power, while OpEx leverage remains enormous and will drive margin expansion further.

Silicon intensity is rising and, historically, this group has outperformed in a rising rate environment. Fiscal stimulus should also support sector and demand trends. What also cannot be ignored is the uptick in the forecast for GDP to levels we haven’t seen in years.

Sector mergers and acquisitions (M&A) are accelerating at a furious pace. The consolidation theme is showing no signs of letting up, as multiple factors will continue to drive this trend.

First, China is aiming to climb up the semiconductor scale as quickly as possible in order to avoid relying on foreign suppliers. Second, product development costs are rising.

Third, there’s exploding growth in automotive end-market usage, as autonomous vehicle (AV) investments from tech behemoths show no sign of slowing down. Fourth, there’s been a shift to advanced nodes — the Taiwan Semiconductor Manufacturing Company Limited (TSMC) recently announced it will be investing over $15 billion toward three and five nanometer technologies.

Fifth, M&A is the quickest and simplest way for larger chip companies to diversify their customer bases. For example, Broadcom (AVGO) is known as the ‘Ultimate Consolidator’ within the tech space, while Qualcomm (QCOM) is buying NXP Semiconductors (NXPI), in a bid to become the world’s #1 auto supplier.

QCOM is attempting to diversify away from mobile basebands, as it looks to leverage its strength in mobile phone technology into NXPI’s automotive and IoT markets. To put things into perspective, look at the value of total deals across the semiconductor space the past several years — $11.5 billion (from eight deals) in 2013, $16.9 billion in 2014, $103.8 billion in 2015, and more than $115 billion in 2016 (from 24 deals).

September 2017 will mark the 10th anniversary of the iPhone’s launch — one of the most revolutionary technological introductions of our generation. It was a product that significantly increased Apple’s (APPL) market share and stock.

It’s always worth reminding those of what former Microsoft CEO Steve Ballmer said about the iPhone launch: “There’s no chance that the iPhone is going to get any significant market share. No chance. It’s a $500 subsidized item”.

As a segment, supply chain has been on a roller coaster ride the past several years. Stories have now shifted to content gains versus handset volumes shipped.

Both Apple and Samsung have been left behind in China, as local original equipment manufacturers (Xiaomi, Huawei, Oppo, Vivo) have been aggressively gaining share as smartphones become commoditized like PCs, TVs and cameras.

Along with the iPhone 8 launch in September 2017, Samsung’s GS8, China subsidies and early 5G rollouts are other drivers to keep an eye on this year.

As we close out 2016 and move into 2017, the two most talked about themes among tech-dedicated investors seem to be AI and AV. Autonomous vehicles appear to be pretty well understood, but AI remains a bit more of a mystery.

Nvidia (NVDA), a designer of graphic processing units, sits at plus-236 percent year-to-date. NVDA’s CEO recently said, “AI is going happen in 2017. It’s not going to happen in 2021. People now realize that we need the computation capability five years earlier.”

It is technology like AI and AV that will only increase the rise in semiconductor stocks.

This isn’t a call on whether or not the SOX continues its ascent in a straight line. I believe the market has gotten way ahead of itself, post-Trump victory, given that we’ve yet to see how any policy implementation will play out.

This analysis is, more or less, a focus on how growth drivers have evolved and shifted the past several years. It highlights that the consolidation theme will only support further pricing power and margin expansion.

Semiconductors have come a long way since transistor radios.

Joel M. Kulina is the Senior Vice President for Institutional Cash Equities at Wedbush Securities. 

The views expressed by contributors are their own and not the views of The Hill. 

 

 

This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change without notice

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