Semiconductors – Supercycle pt. V.

Micron joins the canaries.

• Micron reported good FQ3 2022 results but guided badly blaming a sudden softening in demand that has forced it to slow its expansion sending the most serious warning signal yet for the rest of the sector.
• FQ3 2022 revenues / adj-EPS were $8.64bn / $2.59 broadly in line with forecasts of $8.66 / $2.45 but went on to guide badly and sprinkled its forecasts with bearish commentary.
• FQ4 2022 revenues / adj-EPS are expected to be $6.8bn – $7.6bn / $1.43 – $1.83 far below consensus at $9.05 / $2.62.
• This commentary sent the shares down 8% which then recovered to down 2.5% after Micron said that it expected demand to pick up again in fiscal 2023 which begins in September.
• Micron is seeing a significant softening of demand, particularly in consumer electronics and called out smartphones and PCs in particular.
• Micron is expecting smartphone shipments to decline by 5% this year compared to expectations of 5% growth while PCs could decline by as much as 10%.
• The cause is obvious.
• Thanks to rampant money printing during the pandemic, inflation is now running out of control which is putting substantial pressure on users’ ability to buy electronics.
• Instead of upgrading to a new smartphone or PC, consumers are paying for the pandemic largess through a rapidly rising cost of living meaning that they will keep their devices for longer before they upgrade them.
• The supply chain constraints and the war in Ukraine have not helped the situation but the idea that these are the two main causes of inflation makes no sense at all.
• This is because inflation was already out of control before the war started and items that were not affected by the supply chain shortages have risen in price along with all of the rest.
• Furthermore, despite their commentary, central banks do not have the power to tame inflation because to do that the base rates would need to rise to 10% or more.
• This would have a catastrophic effect on the real estate market and the stock market not to mention governments that are almost all heavily indebted.
• Compared to the 1970s, the levels of debt that currently exist in the economies around the world are far higher meaning that real interest rates could very easily cause a severe depression.
• Instead, we are going to have to suffer high inflation until the money supply which in USA and UK were increased by 33% and 25% respectively in the last 2 years is back in balance with the economy.
• It is at that point that I expect that inflation will have burned itself out and normalise at around 2% which is a process that I expect will take a few years.
• The result of high inflation is a weakening of demand which over time will also help to bring inflation under control as prices are not going to come back down but go back to rising more slowly.
• Micron is reacting to this by slowing the build of its capacity increases and refusing to accept orders from customers who are demanding large price cuts.
• Micron is expecting demand to bounce back in 2023 but I am not so sure as inflation will not be brought under control by the puny interest rises that the central banks can put through before the economy crashes.
• Real interest rates remain heavily negative which in contrast to the tightening commentary are in reality, both accommodative and expansionary.
• Instead, I think that demand may continue to be soft meaning that when capacity does come online, the supercycle that the semiconductor sector has enjoyed will sharply reverse.
• This cycle will be (as it always is) different from all of the others but it will still be a cycle resulting in a painful contraction in the financial performance of many semiconductor companies.
• The fabless semiconductor companies are likely to fare the best given that they don’t own fabs that will need to be filled and so I would continue to prefer the cheaper, more defensive end of the sector.
• Here I continue to prefer Qualcomm and MediaTek both of which may suffer from demand weakness but critically they will suffer less than average.
• TSMC is also pretty cheap on a forward PER basis but if demand really weakens, it may suffer more than the fabless sector and it is also spending a fortune on capacity expansions.
• My caution is growing although some segments like automotive semiconductors remain supply-constrained and are likely to remain strong for the rest of the year.