Semiconductors – Competing factors

2023 likely to be West vs. East.

• TSMC added its voice to Samsung’s in calling out the softness in the semiconductor market and I think that H2 2023 is very much up in the air as strength from China will help offset weakness from the West but there is no indication of by how much.
• TSMC reported Q4 2022 revenues that beat expectations thanks to the weak Taiwanese dollar and cost cuts but guided conservatively given the state of end demand.
• Q4 2024 revenue / net profit of NT$626bn / NT$296bn ahead of forecasts of NT$636bn / NT$287bn (NT$ / US$: 30.3).
• However, it dampened expectations for the coming year with a cut in capex as well as expectations of a “slight growth year”.
• This is a big step down from the growth that the company posted in 2022 and in my opinion, is more than accounted for in the 22% decline in the share price the company suffered in 2022.
• This echoes Samsung’s 70% YoY decline in net profit for Q4 2022 further underpinning that the industry has a difficult 6 months ahead of it.
• The problem has been greatly exacerbated by the pandemic which was characterised by both a big jump in end demand as well as panic component buying from device makers fearful of not being able to source components.
• These two trends hitting at the same time greatly increased demand but now we are seeing precisely the opposite.
• It turns out that the world did not end and that one is able to buy things again and in a recessionary climate, companies are looking to their balance sheets for ways to release cash.
• Winding down inventories that are now both too large for demand and too large given that sourcing is now somewhat easier is further reducing wholesale demand for components coming from semiconductors.
• This is why we are seeing such a sudden and dramatic turn in outlook from those companies that have been brave enough to comment on the outlook for 2023.
• What they see at the moment is continued weakness in developed markets and China remaining at Covid-induced depressed levels.
• While I agree with the former as I don’t see inflation returning to 2% by the end of the year, I think that everyone is being too pessimistic about China.
• Alavan Independent thinks that the CCP’s credibility has been badly damaged by Covid Zero and in order to restore its reputation it needs to score a win with the Chinese people.
• By far the best way of achieving this will be to deliver a rapid economic recovery from which all of China benefits.
• This is well within the CCP’s grasp as PBOC rates are still around 4% and inflation remains low.
• This gives the CCP plenty of space to cut rates and stimulate the economy without printing money and triggering inflation.
• This combined with the Chinese population re-engaging with normal life and the rest of the world is likely to drive a sharp bounce followed by a steady recovery.
• This will be good news for component vendors as this increase in demand has not been planned for and should help to clear out the inventory and improve wholesale component shipments.
• The net result is going to be a trade-off with weaker-than-expected developed markets offset by stronger-than-expected China.
• How this plays out for companies with global sales is very uncertain and I think that is going to be the major theme for this year.
• Here I find TSMC, Qualcomm, MediaTek and Samsung to be the most attractive due to the fact that they already have a cheap valuation and are not pricing in any recovery.
• However, I remain somewhat nervous about owning factories at the moment given how sensitive financial performance is to volume fluctuations.