Structural and Cyclical Drivers Underpin Semiconductor Outperformance

• The secular overweight since 2012 to semiconductor growth themes including sensor, parallel processing and communication chip stocks has outperformed wider tech indices.
• The explosion in video steaming, cloud computing and the shift toward semi-autonomous vehicles as well as the huge computational intensity of AI software are all key drivers through end decade.
• Global semiconductor industry sales saw accelerating growth from mid-2016, with Q4 sales of $93bn 12.3% higher y/y - semiconductors are now more of a core portfolio exposure than say energy.
• The Philly Sox index is up almost 60% in the past year, but Intel with its legacy exposure to PC CPUs has lagged, despite spending over 22% of sales on R&D.
• The tactically bullish view a year ago on DRAM stocks like Hynix has paid off, as an inventory overhang cleared, prices rallied and operating margins soared by Q4 – the market remains tight.
• Component prices are rising broadly, pushing PC selling prices to their highest in 5-6 years
• The same graphic chipsets using parallel rather than sequential processor features developed for high-end gaming are also ideal for ‘training’ AI software and in cloud data centres.
• Rapid sector consolidation since 2014 remains a support and has been driven by soaring R&D costs (which topped $56bn last year) and manufacturing plant capex.
• Actuator/MEMs exposures have lagged, but remain attractive on the embedded intelligence theme i.e. data collecting sensors in virtually every manufactured object.
• The US sector is now trading at 18x forward earnings, slightly above its historical average, but Nvidia stands on a 35x forward PER and looks vulnerable if key customers like Tesla disappoint.