Will Chip Shortage Turn Into a Glut?

If that happens, which name will provide the most downside protection?

Kate Lin, CAIA 16 December, 2021 | 9:59
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Kate Lin: Welcome to Morningstar. The COVID disruptions caused the world to run short of semiconductor chips leading to supply constraints in many things, including cars. The market is thinking that this shortage is going to continue, which is reflected in the stock prices of chip designers and foundries. On the supply side, foundries are pouring millions of dollars into building new capacity. When will the chip demand be finally fulfilled? Our equity analyst, Phelix Lee, is here to answer.

Hi, Phelix.

Phelix Lee: Hi, Kate.

Lin: So, after chip shortage in this couple of years, do you think this issue is going to last or be resolved very soon?

Lee: So, we think the worst is over on the automotive side as foundries have been prioritizing the production of automotive semiconductors since the beginning of 2021 through a series of commercial and political negotiations. So far, all those probably the disruption would end or ease somewhere around in the middle of 2022. But on the overall semiconductor landscape, the lack of new foundry capacity may constrain the supply of other types of semiconductors up to 2024.

Lin: Well, other than a backlog, chip foundries are increasing capital expenditure to expand production. How does it play into supply for years to come?

Lee: So, based on the information we have, most of the major chipmakers have already announced big spending budgets for 2022 to expand their capacity. A lot of these announcements signal that such new capacity will become operational from the second half of 2023 onwards. So, we think, on the cutting edge [products], TSMC and Samsung are working pretty well with their customers in order to minimize the chances of an oversupply. But on the more mature products, which are also more commoditized, we may see an oversupply once such new capacity become available in 2024 and beyond.

Lin: Right. So, with more chip supply entering the market, will chip prices be facing a strong downward pressure and are we paying too much of a premium for chip stocks right now?

Lee: In terms of valuation, I think, if we look at the price-to-book charts of UMC (United Microelectronics Corp, UMC, 2303) and SMIC (Semiconductor Manufacturing International Corporation, 00981, 688981), they are definitely trading at higher levels than 2019 pre-pandemic levels. So, within an oversupply, the prices of such chips, especially those made with more commoditized processes, are more likely to fall, which is what UMC and SMIC are producing. On the more advanced side, we think TSMC may have some downside protection because the chips that they produce have fewer alternatives.

Lin: I see. So, according to your estimates, when the oversupply really happens, which name under your coverage will offer the most downside protection and why?

Lee: We would say TSMC (Taiwan Semiconductor Manufacturing Company, TSM, 2330) offers the most downside protection because it is one of the very few foundries that have a premium pricing and a premium product strategy compared to its peers. So, that's why we think there's more of a downside protection than its peers.

Lin: Awesome. Thank you so much for your time, Phelix. For Morningstar, I'm Kate Lin.

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Kate Lin, CAIA

Kate Lin, CAIA  is a Data Journalist for Morningstar Asia, and is based in Hong Kong

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