Infineon already shares prices in some corrections to the order (OTCQX:IFNNY)
No matter how many times the semiconductor sector proves its cyclicality, there are always analysts and investors ready to declare that “it’s different this time” in the next bull cycle. You can imagine the following, and this cycle has not been different, with some analysts and investors trying to argue that capacity constraints and new end market demand will mean the end of cyclicality in the sector, not to mention that past cycles had the same basic drivers (limited capacity and new growing end markets) .
Despite a strong long-term outlook, I didn’t like Infineon’s (OTCQX:IFNNY) shorter-term outlook in August 2021, and shares are down more than 20% since then, underperforming the SOX index of nearly 15%. At this point, I’m still concerned about the risk that estimates for 2023 (and possibly 2024) are simply too high and that there is additional downside risk as order books and margins shrink. I also note, however, that Infineon shares are already down nearly 40% from their peak and the valuation for longer-term investors looks much more attractive.
Double orders and price rises obscure the true picture of underlying demand
Most semiconductor companies have tried to dispel concerns that customers are ordering twice in an attempt to secure enough chips to meet their needs, but a look at these ordering trends tells a different story. Infineon has about 25 billion euros on its books to deliver over the next 12 months, but only has the capacity to fill about 55% of it in that period.
And yes, I’m sure some customers order expecting delays in delivery (better to get in the queue and get late deliveries than no deliveries) but the level of orders in the industry is still out of proportion to what customers are going through end markets report their own production targets over the next 12-24 months.
At the same time, scarcity drives price increases across the industry. I’ve talked about it in recent articles on ON Semi (ON), NXP (NXPI) and other chip companies and delved into it. Against the backdrop of double-digit year-over-year price increases across the industry, it appears that prices in specific areas such as microcontrollers and power discrete components have increased by 20% or more. These are, naturally, areas where lead times are among the longest and capacity least available, and they are also areas where Infineon is particularly exposed.
At some point, and I expect 2023 to be that point, we are going to see significant normalization. Customers are going to have their inventory in better shape relative to expected demand and they are going to cancel these additional orders, which will reduce lead times and order books, and as the capacity shortage eases, prices and margins will be too.
This won’t happen across all semiconductor categories, and the impact won’t be the same for all products/categories, but it will likely be enough to drive down revenue and margins from what the st currently planning.
Strong in some attractive markets
No semiconductor company offers a perfect end-market exposure profile, but Infineon’s is pretty good.
The company generates more than half of its revenue in power semiconductors, where it has nearly a 20% market share, double that of its nearest competitor (ON Semi) and the triple that of its nearest competitor (STMicro (STM)). Infineon has a wide range of power offerings, but they are particularly strong in high-value power semiconductors used in more demanding applications such as traction inverters for xEV cars, as well as in renewable energy, industrial automation and household appliances.
I’ve talked about xEV opportunities for Infineon before, and I won’t repeat it here, other than to say that the increase in revenue per vehicle is significant ($300 to $450) and there will have significantly more xEVs built over the next 10-20 years.
Renewable energy is also a significant long-term opportunity for Infineon’s high performance energy business. Wind turbines and solar panels both need advanced power chips to supply the energy they generate to power grids, and I expect significant investments in utilities and microgrids in renewable energy in over the next 10 to 20 years.
Other opportunities such as industrial automation and household appliances also remain attractive. The spread of automation in factories will lead to increased demand for more efficient electric motors (which require more sophisticated power management chips), as well as more robots, with Infineon having a potential content of around $200 /unit here only on the power side (they also benefit from the demand for sensors and MCUs). Infineon is also being leveraged for data center growth through its power portfolio as power demands become more robust and sophisticated.
Infineon’s energy portfolio will be the main driver of its future success, but far from the only one. Infineon is also a major player in microcontrollers (or MCUs), MEMS microphones/speakers, sensors and Wi-Fi components.
Microcontrollers are used in a wide range of applications, and although Infineon has historically had more success with microcontrollers for the automotive market (a growing market, giving rise to the growth of increasingly complex subsystems in cars), there are exciting opportunities in a range of other markets, including industrial automation (cobots/robots have significant MCU content – over $100 per).
Sensors are also playing growth opportunities in automotive and industrial end markets, with Infineon taking advantage of increased adoption of more advanced driver assistance systems and more sensors in factory automation system.
Between microcontrollers, sensors and Wi-Fi components, Infineon is also being leveraged for IoT growth, both in industrial and consumer applications. Industrial IoT is expected to grow rapidly as customers seek to offload more tasks such as remote monitoring to smart edge devices, while home automation may continue to drive demand from the consumer side.
One of the things that stands out positively about Infineon is that the company often seems to be one step ahead of many of its rivals. I find this particularly significant on the capacity side, underscored by the company’s February announcement that it was adding a third module at a facility in Malaysia dedicated to manufacturing SiC and GaN wafers. These are high-value categories, as chips fabricated on SiC or GaN have significant power and performance advantages over traditional silicon.
While it may seem contradictory that I applaud capacity growth in the same article where I warn of impending excess capacity and an industry correction, it is about positioning the company for the future and in categories with higher added value. The correction I foresee will be short-lived and Infineon will need capacity to meet future demand in its end markets. In my experience, companies that take a long-term view of capability (including Texas Instruments (TXN)) are outperforming more short-term-focused and responsive competitors, even though these moves sometimes run counter to analysts’ and short-term investors’ expectations.
I’m looking for long-term revenue growth in Infineon’s 8% to 9% range, which is largely in line with what I expected from NXP, ON Semi and STMicro, and for the same reasons – to leverage growth opportunities in vehicle electrification, ADAS, industrial automation, renewable energy, IoT, etc.
I believe Infineon can achieve a 24%-25% operating margin in FY25/26, but I see risks to the FY23 outlook because of this order correction cycle . Over the long term, I expect FCF margins to climb towards 20%, fueling double-digit FCF growth. I have some concerns about the cost of future capacity, but Infineon has the advantage of not needing state-of-the-art technology for most of its production needs.
Between discounted cash flow and margin driven EV/revenue and EV/EBITDA, I think Infineon could be undervalued by around 20%-30% today and priced for annualized returns over the long term two digits.
My biggest hesitation in recommending Infineon (or any of its peers for that matter) is the “risk of dropping the knife” – the idea that even though many of these stocks have already corrected significantly, it could have more room to fall. After all, this cycle has seen new highs for both timeframes and valuation multiples. This risk is somewhat mitigated by the fact that even at the low end of the historical valuation range, Infineon would be no worse than “fairly valued” if the operating margin contracted to 20% in FY23 and that sentiment was moving down the valuation. Scope.
For investors who can take the risk of buying before the bottom, Infineon is definitely worth a look based on its strong position in high-value categories like discrete power and MCU. I don’t want to underestimate the risk of a steeper correction from here, but I think a strong long-term outlook mitigates that for longer-term investors.