The semiconductor shortage is here to stay, but it will affect chip companies differently

As the industry entered 2020, high demand was expected in the mobile chip area because of the rollout of 5G devices. That path was turned on its head when COVID-19 became a global pandemic, driving millions, if not billions, of people into the safety of their homes to work, go to school, be entertained and to socialize.

Demand for chips powering laptops, gaming devices and internet infrastructure skyrocketed, while chip demand for auto and industrial uses plummeted. When the factories that make basic computer components couldn’t make them fast enough, already-long customer waiting lists for those factories got even longer. With demand remaining high and little additional chip-making capacity expected in the short term, the shortage is expected to last into at least next year.

Read: Worldwide chip shortage expected to last into next year, and that’s good news for semiconductor stocks

That dynamic has been good for chip stocks. The PHLX Semiconductor Index SOX, -0.56% has rallied 92% over the past 12 months, when COVID-19 shelter-in-place protocols were just beginning to settle in and people across the world were trying to adapt to the new normal. In comparison, the S&P 500 index SPX, +0.36% rose 50% over that period, and the tech-heavy Nasdaq Composite Index COMP, +0.10% gained 65%.

The supply-demand imbalance will eventually be solved, and investors will want to watch upcoming earnings reports and forecasts for signs of lessening demand or increased supply. So far, no signs have popped up: Chip makers across the board turned in better-than-expected earnings reports and outlooks for 2021, as COVID-19 accelerated a global reliance on a digital infrastructure.

As a new earnings reporting season begins , the different sectors of semiconductors could react differently to the shortage. Here is what to know and look for.

Autos

The chip shortage effectively crippling the auto industry illustrates the worst effects of the phenomenon as crucial parts to produce finished cars and trucks are unavailable and causing automotive manufacturers to halt production.

Ford Motor Co. F, -0.08% said at the end of March it was shutting down production at more plants because of a lack of auto chips, following production cuts of its F-150 pickup truck in February. Several other auto makers announced they had shortages of chips for their cars.

Bernstein analyst Stacy Rasgon told MarketWatch in an interview that the automobile industry shows a stark example of how a disruption of chip supply can affect other industries.

“The auto supply chains had the most whipsaws because of COVID,” Rasgon said.

When COVID hit, auto makers canceled all their orders because auto demand dropped off, Rasgon said. When demand returned, auto makers tried to reorder what they had canceled, but found themselves out of luck because the facilities that made the parts they needed were busy making high-demand components for other industries, Rasgon said. On top of COVID, the recent blizzards in Texas further disrupted the supply chain, and auto makers generally do not keep much inventory on hand when it comes to electronics.

That’s likely to change, Rasgon added.

“We’re going to see some radical changes in supply-chain management because of what’s happened this past year,” Glenn O’Donnell, research director at Forrester, told MarketWatch.

Maribel Lopez, principal analyst at Lopez Research, told MarketWatch that many product designs that rely upon electronic components often take months or years to develop and are vulnerable in that you can’t just “swap out” parts

“If you look at the F-150, it’s a really expensive truck being probably held up by a $50, $60 part, or even less,” Lopez said. “In some cases we had clients that had very expensive products, say it was $1,200, being held up by a 3-cent part.”

And given that autos are held to such high safety standards, you can’t cut corners and hope for the best. It’s a situation where you need to have all the components in a design or you can’t sell the product.

“The issue is you need all of them,” Rasgon said. “If I don’t have a 50-cent microcontroller that controls the seat belt, I don’t build the car.”

Major automobile chip suppliers include Texas Instruments Inc. TXN, -0.64%, Analog Devices Inc. ADI, -0.75%, Netherlands-based NXP Semiconductors NV NXPI, -1.18%, Germany’s Infineon Technologies AG IFX, +0.08%, South Korea’s Samsung Electronics Co. 005930, -0.24%, and Japan’s Renesas Electronics Corp. 6723, +2.48%

“They’re shipping everything they make,” Rasgon said.

Most recently, Intel Corp. INTC, -0.42% told Reuters it’s in talks with companies that design chips for auto makers to start manufacturing those chips for them to resolve supply shortages. Intel is scheduled to report earnings on April 22.

PCs

PC sales got a huge shot in the arm as the world scrambled to adapt to working and going to school from home because of COVID-19. Research firm IDC expects sales volumes to grow by 18% in 2021 with shipments of 357.4 million, after rising nearly 13% in 2020.

“PC demand has been off-the-charts strong,” Rasgon said, adding that IDC’s shipment estimate is above the largest number of PCs shipped in a year, surpassing the record set in 2011 of 352.4 million units. “So the big controversy there is how long is that demand going to last, and how much of it was sustainable?” Rasgon said.

By way of a personal example, Rasgon said he bought four notebook computers last year as a result of COVID, and that businesses and consumers had similar higher-than-usual PC purchases in 2020. While IDC predicts that PC sales growth will continue in 2021, many wonder if that demand has already been sated.

“I’m probably not buying any PCs for a while,” Rasgon said.

Still, makers of CPUs, or central processing units, the chips that act as the brains for every personal PC and public-cloud data center, stand to benefit in a market that is dominated by Intel and Advanced Micro Devices Inc. AMD, -1.04%, which has gradually been taking market share away from larger rival Intel.

AMD also competes with larger rival Nvidia Corp. NVDA, -1.39% in the GPU, or graphics processing unit, space.

See also: Nvidia steps up competition with Intel and AMD with first data-center CPU

Both Nvidia and AMD benefit from “massive supply constraints” because of a significantly better crop of gaming chips this past year as well as a new gaming consoles, and a renewed interest in cryptocurrency mining, Rasgon said. And since, these are high-demand, big ticket items, they’re the most profitable for third-party silicon wafer manufacturers and so they get priority booking, Rasgon said.

“Go out and try to buy a graphics card, good luck,” Rasgon said.

GPUs that are used in data centers are not as supply-constrained, but lead times are exceptionally long because Nvidia still needs to get the components to build the units.

“Everything they’re shipping now was ordered two quarters ago,” Rasgon said. “Because of that, the recent server digestion cycle didn’t affect Nvidia at all.”

Smartphones

Smartphones are also being hit with the supply shortage. Major supplier Qualcomm Inc. QCOM, +0.27% said recently that they would have sold much more product had it not been for supply constraints.

Smartphone suppliers, however, may not get as much as a tailwind that some other chip companies will, Rasgon said. Other smartphone suppliers include Taiwan’s MediaTek Inc. 2454, -1.02%, Broadcom Inc. AVGO, -0.25%, Skyworks Solutions Inc. , Cirrus Logic Inc. CRUS, +0.94%, Qorvo Inc. QRVO, -0.30%, and STMicroelectronics NV STM, +0.10%.

“Unit demand has not been super,” the Bernstein analyst said. “It has gotten less, less bad.”

“Smartphones have been weak for a while,” Rasgon said. “I mean they all look the same like featureless slab of glass . People see less of a need to upgrade.”

One of the biggest heralded boosts for smartphone upgrades over the past few years has been the recently released 5G standard, but Rasgon said that “consumer demand for 5G is zero.”

“People will buy 5G phones because that’s what’s being sold,” he said.

Fabs

“Fabs,” or foundries, are what the semiconductor industry calls the complex manufacturing plants where silicon wafers used in computer chips are fabricated down to billionth-of-a-meter accuracy. When the chip shortages during COVID-19 first became evident, fabs world-wide were already running at capacity and had order backlogs that ran as much as several months.

That’s prompted many fabs to respond by committing to invest hundreds of billions of dollars into building new facilities. That, however, is not only an expensive process but a lengthy one seeing it takes and average of two years between breaking ground and producing the first wafers.

Major third-party fab Taiwan Semiconductor Manufacturing Co. TSM, +0.41% plans to invest up to $100 billion in new fabs over the next three years, while Intel said it plans to spend $20 billion in upgrading its fabs this year and branch out into becoming a third-party manufacture of other companies’ wafer. In its most recent earnings report, TSMC stressed it was making auto customers a top priority and forecast an easing of the shortage by the second quarter.

Meanwhile, Samsung, the other large third-party fab, is expected to keep its capex at around $28 billion in 2021, flat from a year ago, according to IC Insights.

Memory-chip maker Micron Technologies Inc. MU, +0.43% faced questions on why it wasn’t spending more than the $9 billion it was planning to spend this year. As recently as two years ago, Micron cut back on investing in new fab capacity in response to 2018’s chip glut that hamstrung several chip makers with massive inventories.

Additionally, the U.S. has pledged $50 billion to build out domestic chip-making infrastructure.

“The build-outs that we see coming in the next two years are going to be pretty aggressive build-outs,” Forrester’s O’ Donnell said. “There’s a lot of capex being spent.”

“That’s going to take a while so I think this shortage is here with us for a prolonged period of time,” O’ Donnell said.

The big winners here are going to be the companies that make the highly specialized — and expensive — equipment used to build chip foundries. Those companies include Lam Research Corp. LRCX, -0.89%, KLA Corp. KLAC, -1.64%, Applied Materials Inc. AMAT, -0.51%, ASML Holding NV ASML, +0.56%, Entegris Inc. ENTG, -1.61%, MKS Instruments Inc. MKSI, -0.76%, and Teradyne Inc. TER, -1.30%. Excluding Teradyne, all six of those stocks closed at record highs on April 5.

What’s overlooked, however, is how geopolitics are changing the chip sector. Since the U.S. shut China out of several components in trade war, Chinese companies like Huawei have had to look elsewhere, and are being forced to become more independent. That might come back to haunt the U.S. as far as competition goes, O’Donnell said

“China becomes a stronger player just out of sheer necessity, O’Donnell said.