Global semiconductor shortage offers investors opportunity

A global shortage of all types of microchips has caused extended shutdowns at automobile plants and is delaying the launch of some consumer products in a squeeze that will likely continue for the rest of the year.

For investors, it means opportunities in the companies that design and make semiconductors. They’re having a banner year and expect demand to stay strong in the foreseeable future.

“It is an absolute perfect storm,” says Hans Albrecht, vice-president, portfolio manager and options strategist at Horizons ETF Management (Canada) Inc. in Toronto, of the events causing the shortages. “It’s a list of things that have gone wrong, including a disconnect between what people expected and what has happened.”

Demand is escalating for all things related to microchips

as their applications grow. They’re in everything from electric vehicles to factory floor robots to computers, smartphones, cloud-based software, and data analytics.

“We’re not in a normal cycle,” says Ted Mortonson, managing director and technology sector strategist with Baird & Co. in Milwaukee. “The segment driving microchip development is artificial intelligence (AI). AI is everywhere, in every single industry and every piece of hardware. It’s one of the biggest drivers of the internet of things and demand is not going to slow down.”

The shortage has its roots before the COVID-19 pandemic hit. In January, 2020, the industry expected a cyclical slowdown, so inventories were drawn down. Two months later, the pandemic led to factory closures. Many of the microchips come from the Far East, where supply chains “basically froze,” Mr. Mortonson says.

A surprisingly strong rebound in May was led by all types of work-from-home needs – telephones, laptops, tablets, connectivity software, and storage.

On the industrial side, automakers were slow to react. They now find themselves at the back of the line as they favour just-in-time deliveries over fixed contracts. They need microchips for infotainment and digital displays, power brake sensors, warning light indicators, and engine management.

As a result of these shortages, most automakers are cutting production. General Motors Co. GM-N has extended shutdowns at four assembly plants, including its CAMI Assembly Plant in Ingersoll, Ont. Stellantis NV STLA-N, formerly Fiat Chrysler Automobiles NV, closed its Windsor, Ont., plant for three weeks in February.

Consumer electronics product launches are being delayed or slowed. Consumers face higher prices and product unavailability.

Shortages are such that Broadcom Inc. AVGO-Q is making customers place orders for 12 months at a time – non-refundable. Its radio-frequency chips are found in Apple Inc.’s AAPL-Q iPhones.

“I have never seen that in my career,” Mr. Mortonson says.

Even basic products such as memory chips, which are often seen as a barometer of demand, are in low supply. These basic microprocessors store files on a computer, smartphone, or tablet, or photos taken on a digital camera. In a sign of the times, Micron Corp. MU-Q, the largest U.S. maker of memory chips, recently raised its sales and profit outlook.

“Ultimately, the companies will try to pass the costs on,” Mr. Mortonson says. “But companies like Apple can’t. When it’s selling a US$1,200 smartphone, there’s a point at which where demand becomes inelastic.”

Mr. Albrecht sees shortages rather than price increases as the pressure point. “It could be a $2 part going to $4. Is that going to make a big difference in a PlayStation? Probably not.”

The growing demand for microchips for devices that access 5G wireless networks is also squeezing supply. These microchips are smaller and faster, have more capacity and use less power. They have a shorter response time, which is vital for applications where information must be relayed immediately. However, the production of these microchips requires a new, complex and expensive manufacturing process that only certain companies can tackle.

Mr. Mortonson points to Taiwan Semiconductor Manufacturing Co. TSM-N, the world’s largest microchipmaker, and Samsung Electronics Co. Ltd. as leaders in the manufacturing of microchips for 5G devices. Netherlands-based ASML Holding NV ASML-Q, which produces the equipment necessary to manufacture these microchips, is another.

“They are a monopoly. There’s nobody in the world that can do what they do,” he says of ASML.

Mr. Albrecht notes that ASML recently announced price increases, with a reason cited being that the materials it needs are in short supply.

“So, it’s inflation flowing down the line,” he says.

Mr. Mortonson foresees consolidation in the sector as the costs to design new microchips and make the equipment to produce them now costs hundreds of millions of dollars. He sees Intel Corp. INTC-Q and Advanced Micro Devices Inc. AMD-Q as two survivors, because both manufacture in the U.S., and microchip supplies have become a national security concern.

His favourite stock is Nvidia Inc. NVDA-Q, best known for the graphic processor units used in gaming systems and workstations that require high-end graphics processing.

“Nobody does what Nvidia does. It’s years ahead of the competition and it’s going to be tough to stop,” Mr. Mortonson.

Despite the recent shortages driving interest in microchipmakers, both Mr. Mortonson and Mr. Albrecht see the sector as a long-term play.

“[These companies] are home runs through multiple years,” Mr. Mortonson says.

This is an edited version of an that article appeared in the Globe Advisor section of the Globe & Mail’s Report on Business on Mar. 18, 2020. For information on how to reprint this article please view this page.