Semiconductor Industry Earnings: A Look at Upcoming Q2 Expectations

The seminconductor industry is expected report the highest earnings growth out of the information technology sector. What’s been happening in the industry?

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When it comes to technology, there’s no denying that things will keep changing, especially when it comes to the semiconductor industry. That’s because they’re an essential component of technological devices including smartphones, TVs and monitors, medical equipment, servers, automobiles, and much more. If you think about how much those have changed over the years, it becomes clear why this industry continues to evolve at a rapid pace.

While the industry continues to grow in a cyclical fashion, the speed of change contributes to its high volatility, and is typically reflected in company earnings. Out of the seven industries in the S&P 500 (SPX) Information Technology sector, the Semiconductor and Semiconductor Equipment industry is the only one expected to report double-digit earnings growth in the second quarter according to FactSet. If the industry’s earnings projections are excluded from the sector’s blended earnings growth rate of 10.5%, FactSet’s research indicates that it would fall to 4.4%.   

There are several factors, among others, that help drive earnings growth. First off, several companies in the industry had pretty low, or negative, earnings in the same period a year ago. Second, artificial intelligence, cloud computing, big data, the Internet of Things, industrial automation and other trends are driving demand for products that require semiconductors. Another factor is that technology investments by businesses have started to pick up and more companies have indicated that they are planning to increase tech spending; 53% of companies surveyed by Evercore ISI expect to increase tech spending in 2017, the highest level since 2011. 

Semiconductor Industry Select Index YTD Performance

FIGURE 1: RECENT PULLBACK.

The S&P Semiconductor Select Industry Index ($SPSISC) has been volatile in trading over the past several months. After rallying over the past two weeks, it is up 15.39% year-to-date. Chart source: thinkorswim® by TD Ameritrade.  Data source: Standard & Poor’s. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

Growth Drivers

There are many trends driving growth in the semiconductor industry. There has been a massive increase in the amount of data being created by consumers and businesses, increasing demand for servers and data centers. Companies such as Intel (INTC), Nvidia (NVDA) and Qualcomm (QCOM) are just some of the players in the space. 

Beyond servers and data centers, industrial automation, the Internet of Things, smartphones, and automobiles are other factors driving growth. With more companies turning to industrial automation, PwC projects the industrial semiconductor market to grow at a compound annual growth rate of 9.7% until 2019.

Regarding the Internet of Things, McKinsey & Company expects the number of devices that fall into the category to reach 26-30 billion units by 2020 (15-20% annual growth). New smartphones, and increased sales in developing countries, could shift demand for different types of semiconductors, and technologies on the horizon like self-driving cars could have a large impact on companies in the industry.  

Potential Challenges

The PC market, a large consumer of semiconductor-based components, has continued to decline as more people started using mobile devices, and did away with desktop computers. According to research firm Gartner, demand for personal computers has been declining for the last 5 years, and continues to do so according to recent reports. PC makers in the second quarter of 2017 shipped the lowest volume of PCs since 2007.

Another challenge has been due to constantly evolving technology. Because of that, companies in the industry have spent a large amount on research and development (R&D). According to the Semiconductor Industry Association, on average the “U.S. semiconductor industry annually invests about one-fifth of revenue in R&D, including a total of $34 billion in 2016.”

Some major companies that rely heavily on semiconductor-based components have been working to develop consistent standards for products. If consistent standards were implemented, it might help minimize some R&D expenses because companies wouldn’t need to develop the newest, best product. Instead, they would just build products to the specifications desired by their customers. While that could reduce R&D expenses, it might also lead to more commoditization of the products, which could allow companies to pressure suppliers to lower costs, or switch suppliers easily.

Looking Ahead

Micron Technology (MU) already reported at the end of June with revenue and earnings that beat expectations, but other companies in the industry report in the upcoming weeks. Here’s when some of the companies report: Texas Instruments (TI) and Advanced Micro Devices (AMD) on July 25 after market close, Intel (INTC) on July 27 after market close, and Nvidia (NVDA) is expected to report in early August.

Good Trading,
JJ
@TDAJJKinahan

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