Playing the Semiconductor Shortage with 5 Buy-Ranked Stocks

The semiconductor shortage seems to be dragging on forever, and if we listen to experts, it’s going to continue for a while.

– Zacks

That’s because semiconductor fabrication plants (fabs) take 2-3 years to build, and then they have to be qualified and equipped before mass production can begin. Based on what we are hearing from market watchers, analysts and company management, the consumer/computing side is likely to come out of this sooner than the rest, especially the highly competitive, larger players like Apple and Samsung. In fact, they have been ordering above consumption for some time now so they don’t miss a design cycle and production schedules aren’t disturbed.

The capacity crunch is most pronounced in the auto market. Stockpiling really makes a bad situation worse because capacity earmarked for auto was already retooled and repurposed for consumer/computing when automakers cancelled orders back in 2020 in anticipation of protracted weakness in demand. As we all know, that didn’t play out according to expectations, with demand picking up strongly by the end of the year and continuing thereafter.

And for the most part, this capacity is typically in older fabs using older 40nm processes and smaller 200mm wafer sizes. Chip production technology has gone ahead however and today, this kind of production line doesn’t yield a good return on investment. So, chipmakers aren’t exactly racing to build these things.

This would seem to indicate that freeing up older capacity would be the solution to all these problems. But that’s easier said than done because the production lines are shared with less sexy but equally important components like analog and power management chips, display drivers, microcontrollers, sensors and so on, that go into a multitude of things.

When demand follows some logical pattern, chipmakers are able to make adjustments between components to meet it. But when we have some companies stockpiling some components, others grabbing what they can get and every producer using semiconductors asking for more, there’s a likely some inventory imbalance building up.

And this could be terrible for the semiconductor supply chain. Because production may have to be stalled on something like a washing machine if there is supply of sensors but not of microcontrollers (for example) since the washing machine uses both components.

It’s hard to tell exactly what is going on. But some time next year, we could have a situation where there is excess inventory of some components, which will free up capacity for others.

In the meantime, Biden has licensed American suppliers to sell equipment to Huawei, Semiconductor Manufacturing and other Chinese companies that remain blacklisted, so more capacity becomes available. While the tightness in auto chip supply has eased somewhat, it’s very likely that things won’t normalize until the end of 2022, or even in 2023.

As far as overall chip demand is concerned, a slowdown is not expected for a couple more years at least because of the increasingly connected world we live in today that includes more cloud usage, 5G, more IoT, more EVs, more digital entertainment, you name it. All the capacity that’s being built up today could ultimately lead to overcapacity in 2023 or 2024.

But that’s a typical situation for the semiconductor industry that goes through these cycles of tight supplies and strong pricing followed by capacity builds that again lead to extra capacity and stabilizing prices, and then a repetition of these things. Or the cycle could stretch out because of new developments in the digitization of the world.

Given this extremely optimistic outlook, investing in semiconductor stocks seems to be a no-brainer. But we should play with caution because it’s rarely a good idea to pay more. And it’s also important to recognize that the stocks are driven by innovation, so it wouldn’t do to go for a company that has fallen behind on that count. Conversely, it may make sense to pay a bit more for a stock that’s highly innovative.

Consideirng the above, the following stocks belonging to the Zacks classified Electronics – Semiconductors industry (top 17% of Zacks-ranked industries) are worth considering today-

Nova Ltd. NVMI

Israel-based Nova offers metrology solutions combining hardware and cutting-edge software for advanced process control in the lithography, etch, chemical mechanical planarization and deposition stages of semiconductor manufacturing. Its products are used in a number of markets including Israel, Taiwan, the U.S., China and Korea.

The Zacks Rank #1 stock has a B for Value and A for Growth.

The lone analyst offering estimates for this stock expects revenue growth of 53.3% in 2021 and 15.0% in 2022. Earnings growth is expected to be 85.0% and 13.3% in the two years, respectively. Nova’s earnings surprises have been at progressively wider margins in the last four quarters, so either the analyst is too conservative or the company is going from strength to strength.

Nova’s earnings estimates for 2021 and 2022 are up 34 cents (9.8%) and 52 cents (13.7%), respectively in the last 30 days.

Nova shares are up 82.1% over the past year. However, at 30.1X earnings, they are currently trading below their median level of 34.28X over the past year. The S&P 500 trades at 21.81X.

SMART Global Holdings, Inc. SGH

SMART Global Holdings is a designer, manufacturer and supplier of electronic subsystems to OEMs in the computer, industrial, networking, telecommunications, aerospace and defense markets. The company operates primarily in the U.S., Europe, Asia and Latin America.

The Zacks Rank #1 stock has a B for Value and A for Growth.

In the year ending in Aug 2022, SMART Global is currently expected to see revenue and earnings growth of 21.2% and 22.8%, respectively. Estimates for the year are growing rapidly. In the last 30 days, they are up 21 cents (3.4%) on average. In the last 90 days, they are up 65 cents (11.3%).

What’s more, SMART Global shares are up 51.5% over the past year but continue to trade at a mere 8.86X earnings, below its own median level of 12.74X and the S&P 500. So at these levels there is much more upside in the shares.

United Microelectronics UMC

United Microelectronics is a provider of foundry services for high performance semiconductor applications in Taiwan, Singapore, China, Hong Kong, Japan, the U.S., Europe and internationally. In addition to wafer fabrication, it offers mask tooling, IP res, free-of-charge design libraries, and full front-end and backend support.

The Zacks Rank #2 (Buy) stock has an A for both Value and Growth.

United Microelectronics is expected to grow its revenues by 11.4% in 2022, compared to 28.9% expected growth this year. Its expected earnings growth of 23.5% in 2022 is also encouraging, coming off the 92.9% estimated growth this year.

The Zacks Consensus Estimate for United Microelectronics’ earnings is up from 89 cents to a dollar in the last 60 days, which is an increase of 12.4%.

United Microelectronics shares are up 37.9% over the past year. But they trade at 11.82X earnings, which is about half the S&P 500 and below its median level of 14.48X over the past year.

Silicon Motion Technology SIMO

Silicon Motion Technology Corporation is a leading developer of microcontroller ICs for NAND flash storage devices.

The Zacks Rank #2 stock has a Value Score B and Growth Score A.

Silicon Motion is expected to grow its revenue 15.4% in 2022, on top of the 77.6% expected growth this year. Its 2022 earnings are expected to grow 17.2%, on top of the 86.7% growth expected this year.

Silicon Motion’s estimates are also on the rise. They are up 29 cents (4.3%) in the last 30 days.

Silicon Motion shares are up 43.4% year to date but trading at 9.86X earnings, may still be considered cheap (the median multiple over the past year is 13.90X and the S&P currently trades at 21.82X).

Alpha and Omega Semiconductor AOSL

Alpha and Omega Semiconductor designs develops and markets a broad range of power semiconductor ICs targeting high-volume end-market applications, such as notebooks, netbooks, flat panel displays, mobile phone battery packs, set-top boxes, portable media players and power supplies.

The Zacks Rank #1 (Strong Buy) stock has a Value Score B and Growth Score A.

Alpha and Omega’s revenue is currently expected to grow 4.7% in fiscal 2023 ending June. Its earnings are expected to grow 0.74%. In fiscal 2022, the company is expected to grow earnings 39.3% on revenue that’s expected to grow 13.8%.

The estimate revisions trend is also encouraging. In the last 30 days, Alpha and Omega’s earnings estimate for 2022 jumped 67 cents (19.6%) while the 2023 estimate jumped 47 cents (12.9%).

Alpha and Omega shares are up 107.8% over the past year. Still, they trade at 12.02X earnings, below their median value of 14.16X over the past year and the S&P 500.

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