Semiconductors are an essential component of electronic devices, enabling advances in communications, computing, healthcare, military systems, transportation, clean energy and countless other applications. Due to their role in the fabrication of electronic devices, semiconductors are an important part of our lives.
The global semiconductor market size was US$527.9 billion ($737.6 billion) in 2021. The market is projected to grow from US$573.4 billion in 2022 to US$1,380.8 billion in 2029, at a CAGR of 12.2% during the forecast period.
Imagine life without electronic devices. There would be no smartphones, radios, TVs, computers, video games or advanced medical diagnostic equipment.
Types of semiconductors
A semiconductor, a material usually comprising silicon, conducts electricity more than an insulator but is less than a pure conductor. The conductivity and other properties can be altered to meet the specific needs of the electronic component in which it resides.
Memory chips act as temporary storage of data for computing devices. Due to intense competition and consolidation of the memory market companies, memory chip prices are driven very low, allowing only large companies with economies of scale to stay relevant in the industry. This segment accounted for around 25% of semiconductor sales in 2019.
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Microprocessors and logic devices help to carry out the data interchange and manipulation of data in electronic devices such as computers and communication devices. These chips allow processes required to run video games, and other computer programs or applications. With the largest relevance to the industry, this segment accounts for around 42% of total semiconductor sales.
Analogue devices help to translate analogue signals, such as light, touch and voice, into digital signals. Digital music is a good example of how such devices help convert actual sound of songs and performances into digital records, thereafter converting back to sound emitting from speakers or earpieces. This segment accounts for around 13% of semiconductor sales.
Optoelectronics, sensors and discrete devices are used for mainly generating or sensing light. Optoelectronics and sensors are used in areas such as cameras and traffic lights. Discrete devices are designed to perform single electrical function.
Semiconductor industry advancements can be seen in smaller and faster products. The more transistors can fit on a chip, the faster the chip would perform. It’s not surprising that the industry has intense competition to push for new technologies, and lower the cost of production per chip.
Gordon Moore, co-founder of Fairchild Semiconductor and Intel Corp, wrote a paper in 1965 describing observations, eventually called Moore’s Law, that the number of transistors in a dense integrated circuit doubles approximately every two years. In more recent years, Intel executive David House cites the doubling period to be around 18 months instead.
Growing relevance of foundries
Under the constant pressure for chipmakers to innovate, semiconductor companies allocate large research and development (R&D) budgets. According to IC Insights, R&D spending by semiconductor companies worldwide is forecast to grow 9% in 2022 to US$80.5 billion. Semiconductor companies traditionally carry out the entire production process, from design to manufacture. However, many chipmakers have turned to delegating production to other firms, such as foundry companies, whose sole business is manufacturing.
Foundries provide outsourcing of production at lower costs due to their scale of operations and allow semiconductor companies to focus on R&D and designing better chips. This also increased the number of specialised designers and chip-testers which benefit from the outsourcing of functions to allow chip companies to be more efficient and leaner.
Integrated device manufacturers (IDMs) conduct chip design, fabrication and assembly, testing, packaging in-house. Some more famous IDMs include Intel, Samsung Electronics, Micron Technology, Toshiba Corp and Sony Group Corp.
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The fabless firms engage solely on chip design and partner contract foundries with limited or no semiconductor design capability, to manufacture chips. The largest fabless firms include Broadcom, Qualcomm and Nvidia. Reliance on select few larger foundries, mostly in East Asia, has resulted in growing concern over the manufacturing capability of various countries in relation to national security. For example, US share of global fab capacity is forecast to be 8% in 2022, down from 40% in the 1990s.
Considerations for investment in semiconductor industry
Semiconductor industry is highly cyclical. Chipmakers’ stock performance often follows cycles which are based on the underlying demand for chipbased products.
Demand for semiconductors usually tracks the demand for electronic devices such as personal computers, smartphones and other consumer electronic devices. Companies might see demand outstripping supply during times of strong demand which happened during the recent pandemic, where consumers turned to electronic products for work-from-home set-ups, and shifted budgets from travelling to spending on physical products.
Slowing demand can also lead to a vicious cycle for certain chipmakers due to their reaction time. Slowing demand leads to an increase in inventories and distributors’ lowering of prices as consumers are only willing to pay less. This leads to a dilemma where chipmakers have to decide whether to continue production in the face of lower profit margin or subject themselves to various fixed cost factors and overheads if they choose to cut production.
Thus, it will be hard to categorise chipmakers into a single sector as chips are utilised in computing, communication infrastructure, automotive and various consumer electronic products. The only factor which might lead to a sector slowdown would largely be a global recession or supply chain disruption.
Current trends for the semiconductor industry
The semiconductor industry saw spectacular growth during the pandemic due to the surge in demand for electronics as a result of lockdown measures across the globe. It was also accelerated by the digitalisation of both firms — to operate more efficiently via remote work controls — and individuals — who upgrade their personal workstations for better work- or study from-home experiences.
However, the growth story is ending for the consumer space as more economies open up and consumer spending extends to travelling and office usage. Strong growth can still be expected in the data centre market with an increase in cloud infrastructure investment due to the rising demand for cloud services.
The automotive electronics segment might also continue to outperform, with various countries worldwide pushing for electric and autonomous vehicles to stimulate economic growth while targeting carbon emission goals.
Macroeconomic outlook is tougher with high inflation in many countries as they recover from the pandemic amid difficult situations such as central banks’ raising of interest rates, geopolitical tensions between the US and China, as well as Russia’s war on Ukraine. China’s stance of zero-Covid policy also led to cities’ lockdown and stifled economic growth for the country. Lower demand from Chinese firms leads to semiconductor stockpiles rising and continued supply chain disruptions in logistics and production.
Factors to consider when selecting semiconductor stocks for investment
One key consideration is technological leadership and sector exposure for end-products. Semiconductors that are leading in their various segments are likely to continue to lead with stronger brand power and demand. However, it is also important to see if the companies are exposed to the slower personal computing segment or involved in data-centre infrastructure chips or AI chips which are expected to have stronger growth in the near future.
Another consideration would then be the companies’ profit margins and revenue growth. Other than being in the growing sector, they would need to show good profit margins to allow reinvestment in R&D over the long term, as well as strong fundamentals to boost investor confidence in the short to medium term.
Lastly, peer comparison is important in the highly competitive semiconductor industry. In a situation where a company is the only provider in a niche segment, the comparison would be made on the possibility of a new entrant as well as the evaluation of whether the niche segment is scalable or has good long-term prospects.
In the current digital era, it is unavoidable for the global demand for semiconductors to continue to grow over the long run. 5G proliferation might accelerate the growth of the demand and utilisation of semiconductors to provide for Internet of Things. However, with ever-evolving demand for consumer electronics and infrastructure chips, no single company can indefinitely stay relevant without sustaining continuous push for innovation and new product offerings.
Teo Huan Zi is branch manager at Phillip Investor Centre, Phillip Securities