Semiconductors

Investing in one of the 21st century’s most important sectors

Manufacturers of automobiles, video game consoles, mobile phones and even toothbrushes have been impacted by a global shortage of semiconductor integrated circuits (“chips”) due to manufacturing bottlenecks and increased demand for consumer electronic goods in the last year. Prices of these finished goods will move higher and output volumes will be reduced, which includes Apple’s recent announcement that they will reduce their latest iPhone shipments by 10 million units in 2021.  

The supply chain bottlenecks most pronounced in the auto sector today were created as auto demand sharply declined at the onset of Covid-19, which resulted in semiconductor suppliers switching their product output to consumer devices. This meant that in the 2nd half of 2020, when auto demand picked, up there was no spare availability of semiconductors for that sector. The bad news for the auto sector and other sectors affected by semiconductor shortages is that these issues are unlikely to be resolved quickly or cheaply.  

The capital investment required for a single semiconductor factory range from US$10bn to US$40bn, and the construction lead time is up to 5 years. The good news is that the sector will receive the funding required to expand production and meet the burgeoning demand. For example, the US government announcing a US$50bn investment funding package for the sector. The semiconductor industry in totality is expected to spend over US$150bn per annum, or 50% more than 2019 levels, over the next few years on new production facilities. 

Covid-19 resulted in increased demand for a range of electronic devices and ergo semiconductors, including PC’s, laptops and webcams as people adapted to working and learning from home. In addition, the longer-term structural trends remain firmly supportive for semiconductor demand, including increased numbers of electronic components in consumer devices, supported by new technologies, such as 5G networks and autonomous vehicles. A case in point is electric vehicles, which include 5 times the semiconductor content as non-electric vehicles. 

The world’s supply of semiconductors is highly concentrated, with Taiwan being the leader both in terms of volume and quality (producing two-thirds of the world’s semiconductor chips). This poses enormous geopolitical risks, given the precarious nature of the US-China relations and Taiwan’s position. 

Our View

We have several of the world’s largest and most advanced semiconductor companies in our International Equity portfolios, including the leader in graphics processing units Nvidia (NVDA) and the world’s largest semiconductor producer Taiwan Semiconductor Company (TSM). Both these companies are of the highest quality, generate strong returns on capital, are leaders in their respective categories and are expected to be beneficiaries of the increasing demand for semiconductor products over the next decade. We note that while semiconductor stocks are enjoying long term structural growth trends the sector is also highly cyclical, so can go through periods of drawdowns. For that reason, these types of investments are for higher risk profiles with a time horizon beyond 5 years. 

If you wish to discuss any concerns about the current market or about any strategies to do with your financial plans, do not hesitate to call your Financial Adviser.