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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” during the next up-cycle. You can imagine what follows, and this cycle has been no different, with some analysts and investors attempting to claim that capacity constraints and new end-market demand will mean an end to the sector’s cyclicality, never mind the fact that past cycles had those same basic drivers (tight capacity and new growing end-markets).
Despite a strong long-term outlook, I didn’t like the shorter-term outlook for Infineon (OTCQX:IFNNY) back in August of 2021, and the shares are down more than 20% since then, underperforming the SOX index by close to 15%. At this point I’m still worried about the risk that estimates for 2023 (and possibly 2024) are just too high and that there’s further downside risk as orderbooks and margins shrink. I also note, though, that Infineon shares have already fallen close to 40% from their high and the valuation for longer-term investors is looking a lot more interesting.
Double-Ordering And Price Hikes Obscuring The True Underlying Demand Picture
Most semiconductor companies have tried to talk down worries that customers are double-ordering in their attempt to secure enough chips to meet their needs, but a look at those order trends tells a different story. Infineon has roughly EUR 25B in its books for delivery over the next 12 months, but only has the capacity to fulfill somewhere around 55% of that over that time frame.
And yes, I’m sure some customers are ordering with the expectation of delivery pushouts (better to get into the queue and get late deliveries than no deliveries), but the level of orders across the sector is still out of proportion with what customers across the end-markets are signaling with respect to their own production targets over the next 12-24 months.
At the same time, scarcity is driving price hikes across the sector. I’ve talked about this in recent articles ON Semi (ON), NXP (NXPI), and other chip companies and have looked into this further. Against a backdrop of double-digit year-over-year price hikes across the sector, it looks as though pricing in specific areas like MCUs and power discretes is up 20% or more. These are, understandably areas where there are some of the longest lead-times and the least available capacity, and they’re also areas where Infineon has particularly large exposure.
At some point, and I’m expecting 2023 will be that point, we’re going to see significant normalization. Customers are going to have their inventories in better shape with respect to expected demand and they’re going to cancel those extra orders, driving down lead-times and shrinking order books, and as the capacity shortage eases, so too will pricing and margins.
This won’t happen in every single semiconductor category, nor will the impact be equal across all products/categories, but it will likely be enough to drive lower revenues and margins that what the Street is currently forecasting.
Strong In Some Attractive Markets
No semiconductor company offers a perfect end-market exposure profile, but Infineon’s is quite good.
Power Up
The company generates more than half of its revenue in power semiconductors, where it enjoys close to 20% share that is double that of its nearest competitor (ON Semi) and triple that of its next-largest competitor (STMicro (STM)). Infineon has a broad range of offerings within power, but they’re particularly strong in high-value power semiconductors used in more demanding applications like traction inverters for xEV cars, as well as in renewable power, industrial automation, and home appliances.
I’ve talked about the opportunities in xEVs for Infineon before, and I’m not going to rehash that here, other than to say that the revenue uplift per vehicle is significant ($300 to $450) and there are going to be considerably more xEVs built over the next 10-20 years.
Renewable energy is likewise a significant long-term opportunity for Infineon’s high-performance power business. Wind turbines and solar panels both need advanced power chips to deliver the power they generate to utility grids, and I expect significant utility and microgrid investment in renewables over the next 10-20 years.
Other opportunities like industrial automation and appliances remain attractive as well. The spread of automation on factory floors will drive increased demand for more efficient electric motors (which require more sophisticated power management chips), as well as more robots, with Infineon having roughly $200/unit content potential here just on the power side (they will also benefit from sensor and MCU demand). Infineon is also leveraged to data center growth through its power portfolio, as power demands become increasingly robust and sophisticated.
Beyond Power
Infineon’s power portfolio will be the biggest driver of its future success, but far from the only one. Infineon is also a strong player in microcontrollers (or MCUs), MEMS microphones/speakers, sensors, and Wi-Fi components.
MCUs are used in a wide range of applications, and while Infineon has historically had more success with MCUs for the auto market (a growth market, giving the growth in increasingly complex subsystems within cars), there are attractive opportunities in a range of other markets, including industrial automation (cobots/robots have significant MCU content – over $100 per).
Sensors, too, play into growth opportunities in the auto and industrial end-markets, with Infineon leveraged to increased adoption of more advanced driver assistance systems and more sensor content in factory automation system.
Between MCUs, sensors, and Wi-Fi components, Infineon is also leveraged to growth in IoT, both in industrial and consumer applications. Industrial IoT is set to see rapid growth, with customers looking to offload more tasks like remote monitoring to intelligent edge devices, while home automation can continue to drive demand on the consumer side.
The Outlook
One of the things that stands out to me about Infineon in a positive way is that the company often seems to be a step or two ahead of many of its rivals. I find this particularly significant on the capacity side, underlined by the company’s February announcement that it was adding a third module at a facility in Malaysia dedicated to SiC and GaN wafer manufacturing. These are high-value categories, as chips made on a SiC or GaN have meaningful power and performance advantages over traditional silicon.
While it may seem contradictory that I’m applauding capacity growth in the same piece where I warn about an impending surplus of capacity and sector correction, it’s about positioning the company for the future and in higher-value categories. The correction I expect will be short-lived and Infineon will need capacity to serve future demand across its end-markets. In my experience, companies that take a long-term view of capacity (including Texas Instruments (TXN)) outperform competitors that are more focused on the short term and more reactive, even though those decisions sometimes clash with what analysts and investors want in the short term.
I’m looking for long-term revenue growth in the 8% to 9% range from Infineon, largely on par with what I expected from NXP, ON Semi, and STMicro, and for the same reasons – leverage to growth opportunities in vehicle electrification, ADAS, industrial automation, renewable energy, IoT, and so on.
I believe Infineon can get to 24%-25% operating margin in FY’25/26, but I do see risks to the FY’23 outlook from that order correction cycle. Long term, I expect FCF margins to climb toward 20%, fueling double-digit FCF growth. I do have some concerns around what future capacity will cost, but Infineon has the advantage of not needing leading-edge technology for most of its production needs.
Between discounted cash flow and margin-driven EV/revenue and EV/EBITDA, I believe Infineon could be around 20% to 30% undervalued today and priced for double-digit long-term annualized returns.
The Bottom Line
My biggest hesitation with recommending Infineon (or any of its peers for that matter) is the “falling knife risk” – the idea that while many of these stocks have already corrected significantly, there could be more room to fall. After all, this cycle has seen some new highs for both lead-times and valuation multiples. Mitigating that risk somewhat is the fact that even on the low end of the historical valuation range, Infineon would be no worse than “fairly valued” if operating margin contracts to 20% in FY’23 and sentiment shifts to the low end of the valuation range.
For investors who can take the risk of buying in ahead of the bottom, Infineon is definitely worth a look on the basis of its strong position in high-value categories like power discrete and MCU. I don’t want to undersell the risk of a steeper correction from here, but I think a strong long-term outlook mitigates that for longer-term investors.
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