For Europe chip stocks, busi­ness cy­cle re­turns with a vengeance

Gulf Times Business - - BUSINESS -

In­vestors who bet on Euro­pean semi­con­duc­tor stocks to profit from in­no­va­tions be­ing packed into smart­phones and ad­vanced ve­hi­cles are fac­ing the grim re­al­ity that both in­dus­tries are hit­ting a rough patch at the same time.

Es­ca­lat­ing trade fric­tions be­tween the United States and China have con­trib­uted to a sharp slow­down in the car busi­ness, with some man­u­fac­tur­ers now scram­bling to cut costs. Mean­while, the smart­phone mar­ket is cool­ing af­ter years of head­long growth, as even Ap­ple grap­ples with weak iPhone sales and an un­pre­dictable out­look.

“We are star­ing down both bar­rels,” said Neil Cam­pling, global TMT an­a­lyst with Mirabaud Se­cu­ri­ties in Lon­don.

The down­turn has wiped a quar­ter off the Stoxx Europe Semi­con­duc­tor In­dex since it peaked in June, cur­tail­ing a run in which the bench­mark rose nearly three­fold from early 2016. Con­tin­u­ing de­clines in the Euro­pean Pur­chas­ing Man­agers In­dex, which re­flects weak­ness in Ger­many’s world­beat­ing car in­dus­try, sug­gest that the share-price slide may have fur­ther to go.

Global chip sales growth is ex­pected to slow to 2.6% next year from 15.9% in 2018, trade group WSTS fore­casts. Rev­enues in the Euro­pean mar­ket, at $44bn, are just be­low a tenth of the global total.

In­vestors have heard blue-sky talk from com­pa­nies on their longer-term prospects — and hit the ‘sell’ but­ton, pun­ish­ing those that miss fore­casts or fail to of­fer a clear out­look go­ing into 2019. “The mar­ket is say­ing: I don’t be­lieve you,” said An­drew Gar­diner, an an­a­lyst at Bar­clays in Lon­don.”It’s the clas­sic re­ac­tion of semi­con­duc­tor in­vestors in a down­turn.” Slow­downs in the North Amer­i­can, Chi­nese and Euro­pean au­tos mar­kets have trig­gered a se­ries of profit warn­ings from car­mak­ers.

That’s painful for Europe’s two big­gest chip­mak­ers, Ger­many’s In­fi­neon and the Franco- Ital­ian STMi­cro­elec­tron­ics.

Au­tos ac­count for two-fifths of rev­enues at In­fi­neon, and 30% at STM. Ex­ec­u­tives from the two firms were chal­lenged by an­a­lysts on re­cent quar­terly re­sults calls, with STMi­cro ad­mit­ting to “soft mar­ket con­di­tions in China” and In­fi­neon say­ing it saw a “higher like­li­hood of a slow­down”. “They are strug­gling to quan­tify the im­pact,” said Achal Sul­ta­nia, direc­tor of tech­nol­ogy eq­uity re­search at Credit Su­isse in Lon­don.

“The earn­ings cut has not been ma­te­rial — but peo­ple are mark­ing down the mul­ti­ples they are pre­pared to pay to own these stocks.”

More spe­cial­ized play­ers, like Bri­tish op­ti­cal wafer maker IQE, have been caught out by Ap­ple’s warn­ing last month of slower hol­i­day sales.

“The last two years have been ex­tremely ex­cit­ing.

The last two or three days haven’t,” dead­panned CEO Drew Nel­son af­ter IQE said there would be a “ma­te­rial re­duc­tion” in its fi­nan­cial per­for­mance. Yet he still gave an up­beat out­look, telling a re­cent Mor­gan Stan­ley con­fer­ence that 3-D sens­ing tech­nol­ogy would be­come ubiq­ui­tous as it spreads to the An­droid hand­sets that ac­count for most smart­phone sales. There’s lit­tle con­sen­sus among an­a­lysts on the chip sec­tor’s neart­erm prospects, re­flect­ing broader uncer­tainty about the im­pact of the US-China trade war and slow­ing global growth.

Some, like David Mul­hol­land at UBS, have low­ered earn­ings out­looks while keep­ing a more pos­i­tive view on shares in com­pa­nies like Mu­nich-based In­fi­neon, a maker of high-end power chips, which he con­tin­ues to rate a ‘buy’. Mul­hol­land reck­ons that In­fi­neon’s busi­ness line sup­ply­ing elec­tric ve­hi­cles is a “key un­der­pin­ning” worth as much as half of the firm’s en­ter­prise value. Ac­cord­ing to the com­pany, a lux­ury car con­tains $750 worth of sil­i­con. Bears re­spond that with prof­its growth and mar­gins at his­toric highs there is pre­cious lit­tle up­side left, while slow­ing car de­mand and Chi­nese in­dus­trial weak­ness weigh. “You’ve got a vol­ume malaise in high-end smart­phones; a semi­con­duc­tor in­dus­try that lives and dies by vol­umes; record prof­its and mar­gins; and head­winds in au­tos and in­dus­tri­als,” said Cam­pling, list­ing his con­cerns.

The only Euro­pean sec­tor stock to buck the neg­a­tive trend has been Di­a­log Semi­con­duc­tor, which de­signs pow­er­man­age­ment chips used in the Ap­ple iPhone.

Di­a­log may be the ex­cep­tion that proves the rule: The An­glo-Ger­man chip de­signer struck a deal in Oc­to­ber to ac­tu­ally re­duce its ex­po­sure to Ap­ple by swap­ping peo­ple and patents for $600mn in cash.

The com­pany’s shares re­cov­ered on the back of that deal but are still down by more than half from their peak, leav­ing value in the stock ac­cord­ing to Mirabaud’s Cam­pling. Di­a­log “could be the baby that was thrown out with the bath­wa­ter”, he said.

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