After rising 37% in 2016, the Philadelphia Semiconductor Index has tacked on another 10% this year. A string of stellar earnings reports, together with soaring memory sales, improving demand in select end-markets and hopes for further M&A, have bulls as enthusiastic as ever.
With multiples having risen pretty much across the board, a lot of the low-hanging fruit in the space is now gone. But provided one is confident that industry demand and pricing will remain solid, multiples still look fairly reasonable for some prominent names.
On Monday, the Semiconductor Industry Association (SIA) reported global chip sales grew 16.5% annually in February to $26.1 billion, an improvement from the 13.9% growth posted in January. Moreover, in spite of three fewer days, sales only fell 0.8% from January.
The report came just a few days after research firm IC Insights hiked its full-year industry growth forecast to 11% from 5%. In January, Gartner had forecast chip sales would rise 7.2% this year to $364.1 billion.
A boom cycle for DRAM and NAND flash memory has much to do with both the SIA's numbers and IC Insights' revised outlook. The latter now expects DRAM and NAND sales to respectively grow 39% and 25% this year, thanks largely to expected 37% and 22% increases in average selling prices (ASPs) caused by favorable supply/demand balances.
The estimates arrived shortly after DRAM/NAND maker Micron (MU) reported its February quarter sales grew 58% annually, and guided for May quarter sales to be up 86% at the midpoint. In addition to favorable pricing, the company is benefiting from strong server DRAM, solid-state drive (SSD) and mobile memory demand.
But a look at earnings reports from chipmakers operating in other fields shows that conditions are also quite good elsewhere. Makers of analog/mixed-signal chips and microcontrollers (MCUs), such as Texas Instruments (TXN) , Analog Devices (ADI) , Microchip (MCHP) , Cypress Semi (CY) and ON Semi (ON) , have provided strong results and guidance this year. So have Broadcom (AVGO) and Skyworks (SWKS) , both of whom have heavy mobile exposure, and 2016 high-flyer Nvidia (NVDA) .
Many of the analog and MCU vendors have benefited from strong automotive demand, as various initiatives to make cars more intelligent, connected and aware of their surroundings lead to higher chip content per vehicle. TI received 18% of its 2016 revenue from autos, up from 15% in 2015. ON Semi has reported seeing strong demand for image sensors and co-processors used in driver-assistance (ADAS) systems, and Cypress for MCUs and Wi-Fi/Bluetooth connectivity chips.
These firms are also getting a boost from the industrial/medical market, as factory equipment, medical devices and other hardware becomes smarter and more connected. And the tremendous consolidation that has gone on in this space seems to be lifting ASPs and margins.
Elsewhere, improving PC demand is benefiting firms such as Intel (INTC) , AMD (AMD) and Marvell (MRVL) . And as Broadcom and Skyworks' guidance show, Samsung's Galaxy S8 launch and healthy demand from tier-1 Chinese phone makers is helping offset a slowdown in iPhone-related chip orders ahead of this summer's expected iPhone 8 ramp. In the data center chip space, major capital spending ramps from the likes of Google, Amazon and Facebook are offsetting soft enterprise demand. Products getting a lift include Intel's server CPUs, Broadcom's Ethernet switching and packet-processing chips and Nvidia GPUs used to power AI/deep learning projects.
Markets still seem to be hoping that additional firms will get acquired -- names often mentioned in buyout speculation include Cypress, Xilinx (XLNX) and IDT (IDTI) . But as valuations have risen, the pace of buyout activity has slowed a bit, and it might not be a coincidence that the last two big deals -- Qualcomm-NXP and Intel-Mobileye -- both involve using offshore cash to buy a foreign company. An offshore cash tax holiday could fuel a fresh round of deals.
Valuations have gotten elevated for select names. TI, for example, now trades for over 20 times its 2018 EPS consensus, and Nvidia (in spite of a recent selloff) for 30 times its fiscal 2019 (ends in January 2019) consensus. But lower multiples can be found: ON Semi trades for about 10 times its 2018 EPS consensus (low even after accounting for $2.5 billion in net debt), Skyworks and Broadcom each trade for 14 times their fiscal 2018 (they respectively end in September and October) consensus estimates.
And with the qualifier that the company operates in a notoriously cyclical business where earnings often go negative during bad times, Micron trades for only five times its fiscal 2018 (ends in August) consensus. It's quite likely that memory conditions won't remain as good as they currently are forever, particularly for NAND flash, but if a consolidated DRAM industry is able to avoid the mistakes it made in 2015, Micron's multiples might still be low.
In a way, Micron's situation serves as a microcosm for the chip industry in general. Markets are well-aware that conditions have gotten better, but valuations still often suggest a measure of doubt about long the good times will last. And if industry conditions have broadly changed for the better, thanks to M&A and other factors, many names could still have room to run.
