Thread by @RadnorCapital

(1/16) Applied Materials $AMAT, a leading provider of #semiconductor equipment, became the latest company in the #chip space to warn of weakening trends (also ~$400mm impact from #Chinese #export regulations).

(2/16) The semiconductor space has seen a ton of volatility this year, but sector fundamentals and share prices are entirely following the playbook of the last several decades. Let’s take a quick look…

(3/16) The industry continues to be deeply cyclical (despite playing into secular trends like #computing / processing power – meaning the long term trend is bumpy, but higher) with y/y growth rates rising much more than end-demand for products, as well as falling more steeply.

(4/16) This just means that chip end markets like #PC and #auto are less volatile than the chip companies themselves. We’ve spoken about this as it relates to $AMD and $NVDA.

(5/16) The upturns occur during periods of high #demand which cause #supply shortages. Tight supply leads to higher prices and revenue growth. Then downturns are caused by #inventory buildup which result in falling #prices and negative revenue #growth.

(6/16) Exactly the same has happened so far in this cycle and we expect more of the same in coming quarters.

(7/16) This cycle seems to be exacerbated by 1) Covid supply chain issues leading companies to over order inventory to meet demand 2) Covid driven demand for consumer electronics in a work from home world – leading companies to extrapolate past demand trends into the future.

(8/16) As these themes normalize, so do the inventory channels, leading to lower earnings for chip companies.

(9/16) Semiconductor share prices have had a very high level of correlation with the economic cycle over the decades and they have continued to do so in this cycle as well.

(10/16) The fall in the $SOX (semiconductor index) has been bigger so far than in most previous downcycles, with the exception of 2001 and 2009.

Blame rate hikes weakening the economy and the inventory issues mentioned above.

(11/16) Double clicking on the inventory issue…we find the on-going rise in inventory days (number of days it takes for inventory to turn into sales) at various parts of the technology supply chain alarming.

(12/16) And we expect inventory days in the supply chain to continue to rise over the next few quarters, potentially reaching new highs in many areas.

(13/16) What adds to the concern is that it is happening in an environment of slowing end-demand, macro-economic uncertainty and rising capacity levels…

(14/16) More specifically, we believe the inventory build is especially severe in the auto segment, where supply has been the tightest.

(15/16) Here’s the data…at automotive tier 1s (companies that supply parts or systems directly to manufacturers) DIO (days inventory outstanding) has risen to 52 days, a y/y jump of ~24% and ~47% above the average level between 2010 and 2020.

(16/16) Basically this just means companies don’t have any visibility into the channel (or even end market demand?) – so its probably not time to buy chip stocks yet.

While valuations are certainly becoming reasonable, there will be more earnings cuts ahead.