Chip investors have had a bad year. Ironically, things may need to get worse before they get better.
Micron Technology Inc. ( MU ) reported poor first-quarter results late Wednesday, adding more pressure to a sector facing its worst year since the financial crisis. The Philadelphia Semiconductor Index fell more than 4% on Thursday and is down 36% this year. In the past three years, the index has performed well, with an average annual increase of 51%, which is the best in the entire market.
But in typical pattern for the cyclical sector, shares began to fall long before the actual earnings numbers fell. As of the end of June, the Philadelphia Semiconductor Index had fallen 35% for the year, while global semiconductor sales in the first six months were up 23% over the same period in 2021, according to World Semiconductor Trade Statistics. Chip stocks moved lower ahead of time, as seasoned investors are well aware that the shortages at the start of the outbreak won't last and will actually drive up inventories, which will sooner or later lead to a slowdown in sales.
This is happening. Micron’s inventory rose 26% in its most recent quarter to an all-time high of $8.4 billion. The memory chip maker is no stranger to industry cycles, but this was still the largest quarter-over-quarter increase in Micron's quarterly inventory in nearly a decade. Chief executive Sanjay Mehrotra said in a conference call last Wednesday that the industry was experiencing the "worst supply-demand imbalance" in the past 13 years.
The key question now is: When will chip stocks bottom? In his first chip industry report last month, Credit Suisse's Chris Caso noted: "Historically, two-thirds of semiconductor corrections precede the first bad news and most Under the circumstances, the stock price will bottom out in a few months.”
But he also acknowledged that the current cycle is unusual because certain chip segments, such as analog and automotive, have yet to experience a downturn. Many of those buyers, plagued by supply shortages, have begun accumulating more inventories to avoid being caught off guard again. Four of the largest chip companies serving these markets: Texas Instruments Inc. (TXN), NXP Semiconductors NV (NXPI), Microchip Technology Inc. (MCHP) and Analog Devices (ADI) recently Revenue has grown an average of 24% year-over-year for several quarters.
Those companies may need to start showing signs of weakness before investors get bullish on chip stocks as a whole again. This may take a while. In a Dec. 14 report, Susquehanna's Chris Rolland noted that while industry-wide lead times—a measure of the length of time between placing an order and delivering it to the chip industry—had retreated from record highs over the past few months, But November lead times for the analog and MCU chip categories, the latter a key component in cars, were still two to three times their pre-pandemic levels.
Still, there are risks for investors in waiting too long to re-enter the market. Credit Suisse's Caso said chip stocks tend to rise ahead of fundamentals. For this reason, he has a positive rating on Micron, writing in a note to clients last Thursday: "In cyclical areas such as memory, when things sound this bad for suppliers, we prefer Constructive." Chip investors may need to start buying before chipmakers clear their inventories.
