Semiconductor stocks have had a banner year, fueled largely by the artificial intelligence revolution. For investors looking to put money to work in chip stocks, the news is mixed: Valuations have moved higher, requiring a more selective approach. However, pockets of opportunities can be found.
"Valuation bottomed in the second half of 2022 just before ChatGPT went viral," says Morningstar analyst Phelix Lee. Since then, "AI-related growth and the rebound in automotive and industrial markets have driven multiples of semiconductor manufacturers back above the middle of their valuation ranges."
The Morningstar Global Semiconductors Index was up 53.07% for the year to date as of Sept. 17, 2024, but Lee still sees two semiconductor stocks that remain undervalued compared with their fair value:
• Taiwan Semiconductor Manufacturing TSM
• GlobalWafers 6488
"Good buys still exist after a year of artificial intelligence fever," he says.
A list of the semiconductor manufacturing stocks covered by Morningstar can be found at the bottom of this article.
Cyclical Trends Still Critical for Semiconductor Stocks
Even with the AI boom, Lee notes the importance of cyclical manufacturing and demand trends when it comes to semiconductor stocks and the benefits of economic moats when it comes to gross margins and capacity utilization.
While manufacturers are increasing investments, the level should be manageable, Lee says.
On the supply side of the fence, "semiconductor manufacturers are more optimistic than the previous quarter, evidenced by higher capital expenditure outlooks and pipeline capacity,” he says. "We see modest risks of overcapacity in memory as capacity growth is only 5% in 2025."
Despite the fear that manufacturers may be overoptimistic in their expenditures, Lee believes that risks will be concentrated at Chinese foundries. "We think risks will be concentrated at Chinese foundries since they are built on the premise of replacing imports and locally designed chips," he says.
Semiconductor Demand is Expected to Be Tight
Lee anticipates an improved demand picture from auto manufacturers and consumers, with AI providing a "tailwind."
"We believe the current climate of lukewarm capital spending and recovering semiconductor exports indicates that producers are restocking for new product releases but haven't regained enough confidence to embark on the next major wave of expansion," Lee says.
Lee expects a more significant recovery in demand by 2025. "On the demand side, we expect orders for PCs and general servers to improve in 2025 as AI-driven replacement demand picks up," he says.
A Best-in-Class Investing Approach
Taiwan Semiconductor Manufacturing Co. is the dominant foundry with broad AI exposure, Lee says. "TSMC is a primary beneficiary of artificial intelligence as it holds a dominant share in cutting-edge contract manufacturing," says Lee.
On the other hand, GlobalWafers distinguishes itself through effective cost control and its monopoly in the US market, thanks to its investment in a new 300mm wafer plant in Texas.
"It is the only 300mm wafer plant in the US capable of supplying wafers for cutting-edge processes," Lee adds. "This means GlobalWafers will enjoy a four- to five-year monopoly, even if competitors decide to set up plants in the US."
Here's a closer look at Morningstar's picks for semiconductor stocks.
Taiwan Semiconductor Manufacturing
• Fair Value Estimate: $213
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium
"TSMC is a primary beneficiary of artificial intelligence as it has a dominant share in cutting-edge contract manufacturing. It is immune from shifts between cloud AI and edge AI as players of both groups rely on TSMC's supply. We believe TSMC's average selling price will benefit from higher demand at its latest processes, and volume will benefit from bigger chips to ensure AI features on both servers and devices run smoothly.
"We think geopolitical concerns are overblown since TSMC is building new sites in Japan, Germany, and the US. Capital expenditures in overseas plants are higher than in Taiwan, but most of the increment is covered by government subsidies. TSMC said its customers are willing to pay more to offset higher operating costs.
"Shares are trading at 17 times 2025 P/E, which we view as undervalued given TSMC's dominant position and strong earnings-per-share growth in the coming two years."
Read more of Phelix Lee's Analyst Report here.
GlobalWafers
• Fair Value Estimate: TWD 620
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High
"GlobalWafers is a catch-up play that benefits from growing silicon wafer demand thanks to expansions globally. Wafer producers' performance lags their customers' by about two quarters, as customers stock up only when the market is booming. We expect sentiment to improve as electric vehicles, industrials, and other non-AI applications recover in the second half of 2024.
"GlobalWafers is building a new 300mm wafer plant in Texas, next to customers like Intel INTC and Texas Instruments TXN. It is the first new 300mm wafer plant in the US and likely the only one that can supply wafers used in cutting-edge processes. This means GlobalWafers will enjoy a four to five-year monopoly even if competitors change their minds and set up plants in the US.
"Shares are trading at 16 times 2025 P/E, which we think is undervalued as sentiment is near rock-bottom and the company is more successful at managing rising labor and energy costs."
Read more of Phelix Lee's Analyst Report here.
The following are the semiconductor stocks covered by Morningstar analysts:
