Semiconductor stocks will start to gain as the cycle turns

When reading headlines about artificial intelligence (AI), investors can easily mistakenly think that the entire semiconductor industry is in good health. In fact, demand in the broader market is struggling to recover from the post-pandemic slump.

During the Covid-19 pandemic, there has been unprecedented demand for consumer goods, including phones, laptops and cars. Initially this led to shortages, but then the semiconductor industry caught up, causing oversupply.

Slow recovery

The rise of ChatGPT in late 2022 created a countercyclical market for AI chips, but during this period the rest of the semiconductor market remained subdued. In terms of end markets, sales of semiconductors for both PCs and smartphones fell – by 14 percent and 3.5 percent respectively in 2023, and are expected to grow only 4 percent in 2024, according to Deloitte. This would leave them below 2022 levels.

This slow recovery is reflected in the company’s results. Last week Dutch manufacturer of photolithography machines ASML (NL:ASML) announced that net bookings fell 53 percent quarter-on-quarter to 2.6 billion euros in the three months to September. As a result, ASML now expects net sales to be between €30 billion and €35 ​​billion in 2025, lower than previous analyst expectations of €36 billion.

This drop in order book was due to a combination of a slower recovery in markets outside AI and concerns about Chinese demand. Christophe Fouquet, CEO of ASML, blamed the “slow recovery of end markets such as mobile and PC” on customers “crowding out” some of their new manufacturing plants.

So cyclical

The semiconductor industry has always been a notoriously cyclical industry, and even ASML is cautious about predicting when demand for its lithography machines will recover. “We really see our customers delaying their production plants, we don’t see customers changing their minds about those plants,” Fouquet says. “But there is still a long way to go until 2026.”

After ASML’s results, the share price fell by 20 percent, while equipment manufacturers did so Lam Research (US: LRCX) And Applied Materials (USA: AMAT) saw their share prices fall by 13 percent respectively.

Semiconductor supply chains are extremely complex and require a lot of collaboration and long-term planning. Designers like Nvidia (US: NVDA), Qualcomm (US: QCOM) And AMD (US: AMD) will be in constant negotiations with manufacturers such as TSMC (TW:2330) And Intel (US:INTC) around their capacity.

The manufacturers will then plan how much they will invest in their production plants, known as fabs, to meet this future demand. Once this planning is complete, the chip manufacturers will place an order with the equipment manufacturers, such as ASML and Lam Research.

Because this is all taking quite a long time, there are concerns that ASML’s disappointing results are an indicator of the near-term future of the sector. “ASML’s earnings results show a slower recovery of logic and memory, with specific customers seeing a slower increase,” warned Jefferies analyst Blayne Curtis.

However, TSMC does not appear to be one of these ‘specific customers’. The Taiwanese company reported just after ASML and its year-on-year net profit rose 54 percent to NT$325 billion (£7.8 billion). This was driven by ‘extremely robust’ AI-related demand. “For PCs and smartphones, unit demand growth remains low, but TSMC is benefiting from increased smartphone content driven by demand for edge AI,” Curtis said.

As the most advanced chipmaker, TSMC is the most exposed to the AI ​​boom, and announced on its earnings call that it had no plans to cut growth spending. This means that ASML’s reduced order book is most likely the result of reducing orders by manufacturers such as Intel.

Unlike TSMC, Intel makes almost no money from AI, relying instead on the PC and server markets. In the three months to June, revenues fell slightly to $12.8 billion, while net profit fluctuated from a profit of $1.5 billion to a loss of $1.6 billion. In response, Intel announced that it would reduce gross capital expenditures by more than 20 percent in 2024 from previous forecasts and that there would be no significant increase in expenditures in 2025. It also suspended its dividend.

Green shoots

In the same way, Texas Instruments (US: TXN) has also struggled. The company produces analog semiconductors for the automotive and industrial sectors. Instead of doing logical computing, analog chips convert real-world signals into data, making them useful for sensors. There isn’t much demand for these chips at the moment, and Texas Instruments saw its sales fall 8 percent year-on-year in the three months to September.

This was driven by a continued decline in industrial customers, but there were some signs of recovery, with other end markets, including automotive, growing sequentially. “The lower December numbers were largely expected, but the broader recovery and growth in the auto sector was better than expected,” said Jefferies analyst Curtis.

The world is inevitably becoming more and more digitalized, but not at a constant pace. But even if ASML can’t tell us if this will be in 2025 or beyond, the recovery should come eventually as the cycle shifts again.