You may have heard of the global semiconductor chip shortage on mainstream media by now and may be wondering how serious this issue is.
Semiconductors are essential components found in many electronic devices that have been integral to our modern life. Devices like medical equipment, smartphones, and even remote controllers, all depends on this material.
However, since last year, the semiconductor industry has been facing a shortage of semiconductor chips due to the unexpected demand for electronic devices caused by the lockdowns around the world.
The problem that’s brewing
One of the industries that are affected is the automaker industry, especially those that are producing electric vehicles. As reported by CNA, chip shortage could cost automakers US$110 billion in lost revenues this year, up from a prior estimate of US$61. Consulting firm AlixPartners forecasts that the crisis will impact the production of 3.9 million vehicles.
The investment community has caught on with this problem and have been adding multiple semiconductors company into their portfolios. iShares PHLX Semiconductor ETF (Nasdaq: SOXX), an ETF tracking US companies that design, manufacture, and distribute semiconductors is up 72%, from a year ago.
In this article, we will examine the cause of the semiconductor chips shortage, its impact and most importantly, are there any investment opportunities for us to capitalise on?
What caused the semiconductor chips shortage?
The shortage of global semiconductor stems from two main reasons:
- an overestimation of the pandemic’s impact and,
- the rise in tension between the US and China.
Miscalculating the Pandemic’s Impact
During the early days of the pandemic, many countries went into lockdown mode. In anticipation of a slow down of global economies, companies like those in the automaker industries cancelled their orders for chips used in car electronics systems. They expected the demand for cars to drop.
However, to their surprise, car sales rebounded in the third quarter last year, way faster than anticipated.
This led to a rush to reorder the chips that had initially cancelled from chip foundries. Unfortunately, many chip foundries like Taiwan Semiconductor Manufacturing Corp (TSMC) had already reassigned the spare capacity for the year to consumer electronics companies that produce electronics like computers, which had shot up in demand, due to the lockdowns.
While the surge in demand has prompt chip foundries to increase their production capacity by building more foundries, this could not happen overnight. It takes years to plan and construct new foundries.
The inability to increase production is further exacerbated by the social distancing requirements in factories and the disruption in supply chain logistics caused by the pandemic.
The Rise of US-China Tensions
Secondly, the tense relationship between the two largest economies has also added to the current problem. As US-China tension rose, many companies especially those situated in China were concerned about the disruption in their supply chain.
Companies like Huawei Technologies Co, had begun stockpiling semiconductor chips in 2019, in the anticipation of being place on the US trade blacklist.
The demand was so big that the Chinese imports of chips came in at US$380 billion in 2020, making up a fifth of the country’s overall import for the year. Other anxious buyers who were afraid they will not receive their orders also began double booking, which worsened the problem.
Which industries are facing a crunch?
The automotive industries which run on a just in time model were the first to be affected by the shortage.
Carmakers like Toyota Motor Corp and Honda Motor Co Ltd has recently announced the suspension of productions in various factories after citing supply chain issues which include the current chip shortage.
While these two companies do not focus solely on electric vehicles like Tesla, their productions are also impacted as most modern cars now are fitted with more electronics than ever before. Systems like active suspension, regenerative braking and head-up display all depend on these chips.
Source: deloitte
The problem faced by the automotive industries has starting to spill over to other industries that rely heavily on chips.
Companies producing consumer electronics and home appliances has seen a spike in demand for their products but were not able to cope due to the limited chips. Some of these companies are:
- Sony (Entertainment devices like Playstation5),
- Apple (Productivity devices like iPad), and
- Midea Group (Home appliances).
Are there Opportunities for Investors?
With the ongoing shortage, stocks in the semiconductor industry have done well for 2020 and the first half of 2021.
If this shortage continues (which is highly likely), these stocks could continue to perform well and this could be an opportunity for you to capitalise on.
Companies that you can look at include semiconductor chips foundries like TSMC (NYSE: TSM) and Intel (NASDAQ: INTC) which are planning to spend $100 billion and $20 billion respectively to bring new fabs online.
As these new fabs and existing ones would need to be fitted with semiconductor manufacturing equipment, companies like ASML Holdings (NASDAQ: ASML) and Applied Materials (NASDAQ: AMAT) could also potentially benefit from this shortage.
Nonetheless, the rush to buy into these semiconductors stocks has already pushed up the valuation of these companies up. As such you should only enter if you still believe there is room for capital appreciation
On the other hand, the shortage has also affected some industries as mentioned above. These are stocks that you should be more cautious of, if you believe that the shortage in semiconductor chips will continue to affect their productions and hence revenue.
You can also consider Semiconductor ETFs if you prefer not to pick stocks.
Risks
It is undeniable that the long-term trend for semiconductor is trending up and will continue to do so in our increasingly digitalised world. As such, betting on companies in this industry could bring about good returns in the long term.
Nonetheless, the unpredictability of its demand remains a short-term risk.
As a result of the ongoing shortage, many semiconductor foundries are working to expand their capacity.
TSMC, the leading semiconductor foundries which has a revenue share of 56% worldwide, said it would invest US$2.87 billion to expand its production capacity at its fab at Nanjing, China (The fab which is part of TSMC US$100 billion investment plan over the next three years is expected to run with an increase in capacity after the second half of 2022).
Intel has also announced plans to invest about US$20 billion to build two new fabs in Arizona.
These are not all, we also have countries like South Korea, China, and the EU planning to increase their production.
This signals a huge increase in supply over the coming and if demand from digitalization can keep up with it, there should not be a problem.
Potential Oversupply in the Near Future
Unfortunately, there may be an inventory correction looming for the semiconductor industry. While the shortage is partly caused by actual demand, it is also partly fuelled by inventory stockpiling and double booking as mentioned above.
The impact of inventory management on chip shortage is hard to measure. However, we know that this phenomenon is real and could potentially lead to an oversupply in the short term as new fabs start to come online and companies decide to use their stockpile instead of ordering more.
In the short term, this may cause an oversupply of semiconductors which can adversely affect semiconductor companies.
Investment opportunity
Bearing the risk in mind, we can still safely say the semiconductor industry will grow in the long term.
With digitalization and urbanization, we are much more dependent on semiconductors than ever before and the demand for this material will unlikely fade in the foreseeable future.
Nonetheless, we may not know which semiconductor company will do well in the future due to the unpredictability of the industry.
It is highly competitive. Companies have to compete to produce the most technologically advanced semiconductor and even combat natural events like the recent drought in Taiwan that TSMC, the largest semiconductor foundry is suffering from.
As such here are two semiconductor ETFs you can consider getting to bet on the whole industry, instead of any individual companies.
iShares PHLX Semiconductor ETF (Nasdaq: SOXX)
The iShares PHLX Semiconductor ETF* aims to track the Semiconductor Index which comprises thirty US companies that design, manufacture, and distribute semiconductors.
Since its inception on 10 Jul 2001, it has provided 10.83% annual returns for investors. With one of the largest assets under its management ($6,225 million) and a low expense ratio of 0.46%, this a great ETF that investors can consider.
*Beginning on or around June 21, 2021, the fund will seek to track a new underlying index, the ICE Semiconductor Index, and will cease to track the PHLX SOX Semiconductor Sector Index. The fund name will also change to iShares Semiconductor ETF.
Currently, the top 10 of iShares PHLX Semiconductor ETF are as shown below:
Global X China Semiconductor ETF (HKEX: 3191)
China has long lagged behind many countries in terms of semiconductor chips production. Instead, they have been relying heavily on imports to meet their semiconductor chips demand.
Currently, Semiconductor Manufacturing International Corporation (SMIC), China’s largest chipmaker, only have the ability to produce 14-nanometre chips which are far behind its competitors. Foundries like TSMC have already started the production of 5-nanometre chips (the smaller the better).
While China can continue to rely on its trading partner, things have changed in recent years.
As tension between the US and China rises, the US has been slapping China with multiple restrictions that inhibit the growth of China’s leading technology companies. These restrict many Chinese tech companies’ access to semiconductors from US firms. At the same time, they also cut Chinese companies off from US suppliers and technology, which many global chipmakers rely on for the software and machines to manufacture semiconductors.
Given the importance of semiconductor chips to China, it has pushed them to focus on building up their capability in this sector to reduce their reliance on other countries.
As part of the Made in China 2025 plan, China has emphasised its long-term goal of being self-sufficient in semiconductor chips production. Once again in its recent 14th Five Year plan that happened in March 2021, China has reemphasised transforming itself into a self-reliant technological and manufacturing powerhouse.
From 2021 to 2025, R&D spending will be ramped up by more than 7% yearly and more favourable tax policies has been implemented to help local semiconductor companies.
All these could lead to huge growth for China’s Semiconductor Industry and investors who want to be part of this growth can consider investing in the Global X China Semiconductor ETF.
This ETF which was recently listed on 6 Aug 2020, tracks the FactSet China Semiconductor Index which comprises 25 Chinese semiconductors companies in its holding. The top 10 holding of this ETF includes SMIC which we have mentioned above and other companies that will stand to benefit from China policy.
The management fee for this ETF is also low at 0.50% which make this an attractive ETF for investors.
Of course, even with its great ambitions, we have to understand that semiconductors are complex product, and it is not possible for China to replicate the technology in an instance.
This will take a lot of capital and time before China can be on par with other countries. Nonetheless, this can be a good bet on China.
Other alternatives
Here is a list of all Semiconductors ETFs being traded in the USA:
Source: etfdb.com
If ETFs are not your cup of tea, you can choose to invest in individual semiconductor companies which in the long run could generate a higher return (though with higher volatility).
Here are some companies that you can consider researching:
- Nvidia (NASDAQ: NVDA)
- Intel (NASDAQ: INTC)
- Advanced Micro Devices (NASDAQ: AMD)
- Texas Instruments (NASDAQ: TXN)
- Broadcom (NASDAQ: AVGO)
- Taiwan Semiconductor Manufacturing Company (NYSE: TSM / TPE: 2330)
- ASML Holdings (NASDAQ: ASML)
Concluding thoughts
The semiconductor industry is an up and coming industry with huge application to our day-to-day life.
Investors may choose to ride along with this trend, if the growth in this industry seems compelling to you. If you are vested with EV companies and believe in their future growth, semiconductor companies may also appeal to you, given the vast number of chips required in the coming years to build these electric vehicles.
On the other hand, it is understandable why investors may choose to avoid this industry. Semiconductors are commodities which prices can be quite volatile, due to the long lead time requirements and the unpredictability nature of their demand. Any stock in this industry can experience cyclical share performance, as it goes up and down in tandem with the economic cycle.
Nonetheless, you have to do your due diligence and only buy when the stock or ETF is undervalued. Do not FOMO and chase after it as that usually does not end well.