As digitization continues uninterrupted, semiconductor market cycles should become less volatile, still market whipsaws open opportunities for active managers.
Semiconductors Make the World Go Round
Since the 1990s, the “Internet of Things” has altered how we live, do business, and even communicate with one another. From smartphones to televisions to refrigerators and cars, it is hard to go more than a few hours these days without using a semiconductor-enabled digital device. Semiconductor chips have become ubiquitous — without them, many products simply will not work.
In addition, the level of digitization in our personal and business lives has become more pervasive. We rely on newer technologies such as digital payment systems, machine learning, blockchain technology, and cloud computing which, in turn, generates exponential growth in data that is generated each and every day. All this data needs to be processed, organized, stored, and used. To meet these soaring needs, data storage centers are being rapidly built, with the most significant investments coming from hyperscale players, such as Apple or Google. This trend will ultimately drive additional growth in semiconductors because semiconductor chips are essential in powering data centers and computer processing. Thus, as society’s insatiable hunger for modern technologies continues to grow and the speed of innovation continues to keep pace with demand, we believe the semiconductor industry is poised to benefit. To illustrate our point, let’s examine a key contributor to semiconductor industry growth — the electric vehicles market.
Case Study: The Automation and Electrification of Vehicles
The automotive industry has been a driving force in semiconductor penetration in the electrification of cars. For example, if one looks under the hood of an electric vehicle, you will find numerous electronic control units which control everything from the brakes and headlights to the latest gadgets such as parking cameras and radars. None of these features are possible without semiconductor chips. More importantly, semiconductors are a fundamental component in constructing the car battery that will power the next generation of electric vehicles. As seen in Figure 1, the amount of semiconductor content increases substantially by the degree of electrification and autonomy.
In other words, the more sophisticated or “smart” a car is, the more semiconductors will be required.
Consequently, as electric vehicles and autonomous features become more widely adopted, semiconductor chip demand will grow, presenting opportunities for semiconductor manufacturers. In fact, according to McKinsey, electric vehicle adoption is forecasted to reach 45% by 2035 globally based on the currently expected regulatory targets around net-zero emissions.
How Can Investors Capture These Opportunities?
Investors should consider that the semiconductor industry has undergone a significant structural change, driven by the demand for digital connectivity in every aspect of our lives. Historically, the semiconductor market performance was very cyclical, fueled by the boom-and-bust cycles of the PC and notebook markets. Today, in the digital era where remote working, electric vehicles, and artificial intelligence have become megatrends, we expect semiconductor market cycles to become less acute and pernicious than in the past. According to McKinsey, “the global semiconductor industry is poised for a decade of growth and is projected to become a trillion-dollar industry by 2030.” Given the attractive structural growth story of this sector, we believe it will manifest in higher earnings multiples over the course of a market cycle.
Still, we recognize the volatility of this sector and whipsaw nature of the equities market has created much turmoil for investors. However, we believe that volatility can lead to opportunities, and it is wise to embrace current volatility to our advantage. Thus, we are focusing our energy on buying the “best of breed” semiconductor companies with durable businesses and strong returns on capital. Due to the diverse opportunity set in this sector, from higher beta growth companies to the more mature businesses offering stable income through dividends, we believe semiconductor investments could provide added value to investors’ portfolios — regardless of where they sit on the risk spectrum. Given these varied opportunities that could be suitable for a broad range of risk appetites, we believe it is worthwhile for investors to look at the semiconductor space.
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