Chip Sector Bloodbath Could Persist; These 2 Stocks Can Weather The Storm

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Q3 2018 earnings have confirmed investors’ worst fears for the world’s largest chip makers: the demand slowdown is more widespread and enduring than what was earlier communicated by industry executives. The most recent quarterly reports from some of the sector’s highest flyers show that producers are facing cyclical headwinds which will continue to pressure their share valuations.

The biggest sign of this pronounced slowdown came from Texas Instruments (NASDAQ:TXN), which has the largest number of customers and the broadest product range in the chip industry. The Dallas-based company warned that demand is slowing across many of its markets, predicting its biggest sequential decline in revenue since 2012.

Advanced Micro Devices (NASDAQ:AMD) and Nvidia (NASDAQ:NVDA), the biggest maker of chips for computer graphics cards, followed with their own disappointing sales forecasts.

After the cryptocurrency market crash, which, until early this year fueled demand for chip makers’ product, some top producers are predicting a bleaker future. This comes at a time when rising interest rates and the escalating trade war between the world’s largest economies—China and the US—are adding to uncertainty and cost pressures.

Indeed, China buys more computer chips than any other country, consuming about $140 billion, or 38%, of the world’s semiconductors, according to research firm IC Insights. The US, on the other hand, is home to the largest chip makers, which leaves the industry exposed to tariffs and other trade barriers.

Chip Stocks Bloodbath to Continue

The worsening macro environment, cyclical downturn, and gloomy earnings season have all precipitated in pummeling semiconductor shares. Plus, there’s no sign the bottom has been reached as yet.

Hardest hit are such companies as Nvidia and Advanced Micro, which were exposed to the crypto-mania demand, a segment that dried up after digital currency valuations crashed.

Shares of Nvidia have fallen more than 36% during the past six months, while AMD has lost about half of its value since reaching its 52-week high in September. After two years of more than 30% gains, the Philadelphia Semiconductor Index, the industry benchmark, is down almost 6% for 2018.

It’s difficult to predict when this weakness will pass, but amid the gloom investors shouldn’t ignore where the underlying strength within the industry resides. In our view, the new sources of demand—such as artificial intelligence, the rise of cloud computing and the world’s obsession with video games—are unlikely to dry up anytime soon.

That said, we believe the time isn’t ripe to buy chip stocks. It’s better to stay on the sidelines until the macro environment improves and demand dynamics become more clear. Both AMD and Nvidia are particularly vulnerable to further weakness, driven by their excess inventories for gaming GPUs and collapse of crypto mining sales.

However, if you’re looking for the right moment to make a contrarian bet on the sector, we believe Intel (NASDAQ:INTC) and Texas Instruments are better positioned to weather this storm.

Chip Sector Bloodbath Could Persist; These 2 Stocks Can Weather The Storm

INTC Weekly 2015-2018

In the third quarter, Intel not only beat sales and earnings estimates, the company also raised its full-year guidance. Intel is planning to spend around $1.5 billion more on capex this year than it originally expected. The company’s forward price-to-earnings multiple of 10.5 also makes it one of the cheapest picks in the sector. The stock closed yesterday at $48.

Chip Sector Bloodbath Could Persist; These 2 Stocks Can Weather The Storm

TXN Weekly 2015-2018

Texas Instruments’ strength comes from its diverse line of products. Its chips perform the fundamental task of translating real-world inputs, such as sounds and touch, into electronic signals. This makes the company less vulnerable to sudden demand swings or competitive pressure. In 2017, 54% of TI’s revenue came from automotive and industrial applications.

Bottom Line

The chip stock sell-off is likely to continue until there’s some improvement in the overall macro environment, especially in US-China trade relations. Both Intel and Texas Instruments are selling below the highs made earlier this year. In early 2018 TI hit a high of $119; the stock closed yesterday at $94.62, putting it 20% below where it started the year. Intel hit $57.60 in May, but, as of last night’s close is now down almost 17% from that level.

Both stocks attractive picks based on the current dip or any further weakness due to their compelling valuations and superior market positioning.

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