A recovery roadmap and top picks of chip stock from BofA

Analysts Notebook wrote a column · May 26, 2022 07:29

Since the beginning of the year, the semiconductor industry has underperformed as markets have shifted into a corrective territory. $PHLX Semiconductor Index(.SOX.US)$ is down 27% so far this year, back to its level in 2020, worse than $S&P 500 Index(.SPX.US)$ , down 16% as investors worry about rates, recession, and supply chain disruptions. Besides, $NVIDIA(NVDA.US)$ is trading lower in late trading Wednesday after the chipmaker provided a softer-than-expected outlook for its July quarter.

Here are some highlights from the Bank of America's late report on the semiconductor sector.

Some factors could be recovery catalyst

Reversing chip stock momentum requires a catalyst which could be：

1) Supply chain shortages ease.

2) Affirmation of a seasonal Q3 consumer PC and smartphone demand.

3) Resilience in data center and enterprise demand (cloud Capex/IT budgets).

4) Recovery in growth leaders of prior years including NVDA, AMD, MRVL, and others.

Anatomy of prior downturns and the 3% GDP rule

Based on the last two decades (2003-2022) of semiconductor industry sales, BofA observes that a downturn in semis could be shallow as long as global GDP stays around 3%：

A recovery roadmap and top picks of chip stock from BofA

1) Except for 2012, semi sales have never been negative when global GDP was >3%, which is currently projected for 2022/2023 by BofA forecasts.

2) When global GDP did grow 3%+, semi sales were twice as likely as GDP growth, boosted by rising chip content.

3) Semi downturns have been sharp but quick(l-2 quarters) and relatively shallow on an annualized basis. The average annual decline since 2003 was only 5%, with a range of 0.2% to 12%.

4) Memory sales proved to be more volatile in the down years, declining by 10%, with core (non-memory) sales holding up better. Indeed the most recent 2019 downturn had semi sales down 10%, but ex the 33% decline in memory, core-semi sales declined only 2%.

High-quality cyclical growth sector at “value” multiples

Since its peak in 2021, SOX NTM PE compressed by 36% to 14x (vs.16x historical), the worst in the past decade (average 27%).

From an EV/FCF perspective, BofA estimates that semiconductor stocks are trading at 20x multiple EV/FCF in 2022, which is well below the 25x multiple for Russell 1000 Value (as of 4/30). Semis are expected to generate 24% FCF margins in 2022, while all SPX stocks generate 10%.

“Follow the money” in Cloud, Cars, and Capex

The top picks of BofA are consistent as the downturn appears to be more about resetting valuation by the new rate regime than a structural shift in demand drivers. The favorite ideas of BofA exposed to resilient demand：