Semiconductor stock prices looking increasingly detached from reality
Besides less than a handful of Asian technology names which we continue to like, namely TSMC which has topped our buy list since May of last year, we have become increasingly concerned that the sector as a whole which in Japan had already strongly outperformed the broader market last year and have seen more notable gains thus far this year, look primed for a big correction. To be sure, almost every scenario which has emerged had pushed the sector higher, whether that is the AI-led growth or hopes for a Fed pivot, Chinese scrambling to buy everything they can get their hands on or the latest positive guidance from TSMC which as we have argued has little bearing for many of the names that have rallied since.
Our key concern remains China which has been a massive source of sales growth for IC manufacturing tools and material makers, having gone from single digit percentage to nearly half their revenues in less than a year. Even in the latest quarter where demand for cutting edge tools have rebounded elsewhere, Chinese chip makers’ have continued to dominate sales. The case in point is ASML which more or less owns the cutting edge lithography tools where bookings have been very strong but whose sales to China remained well above 40%.
Not only China’s accelerated move to become more self-sufficient in semiconductors has led to rushed orders and heavy front-loading of their medium term spending plans to avoid tighter export restrictions from the West, but there are growing concerns that these plans are likely leading to a massive overcapacity in maturer processes that could result in big declines in chip prices. In turn we think this will ultimately lead to a notable plunge in spending that could last until 2026. Indeed, despite strong demand for cutting edge chips used in AI which we think will help a select few industry players, we think the overcapacity for industrial and auto chips which have are already become noticeable, could have a massive negative impact on much of the rest of the market and valuations of the sector as a whole.
Another major cause for concern are reports suggesting that the surge in China’s mature process production may begin to dominate global market and lead to dumping of chips that could impact Western suppliers. This may lead to the US export restrictions becoming much more severe to encompass more legacy tools which until now have managed to escape the export bans. Moreover, just like current concerns about China’s overcapacity in EV manufacturing, recent report from Chinese semiconductor research institute (ICWISE) has also warned domestic players to keep supply/demand in mind, especially smaller players that have been financially aided by the state which could fall by the way side if utilisation rates struggle.
Looking at sector analysts’ medium term earnings projections for key semiconductor-related players in Japan, particularly the tool makers which on average are now trading at a notable valuation premiums to their US counterparts, we see no signs at all that any possible declines in Chinese-related sales have been accounted for. Nor do we detect any caution regarding geopolitical disruptions to current valuations of tech names which we believe leave the sector primed for negative surprises ahead. For all the reasons above, our list of short sell candidates is currently populated with Japan’s chip-related names that we believe the market has become particularly complacent about.
