Semiconductor Avalanche? Real Resilience Only Comes After the Most Devastating Drops input: ====== 任天堂公布 Switch OLED 模型，10 月 8 日发售，售价为 349.99 美元。 ====== output: Nintendo unveils Switch OLED model, set to release on October 8th at a price of $349.99.

The semiconductor industry has been showing a continuous downward trend over the past year. According to LONGPORT's data, the cumulative decline of the U.S. Philadelphia Semiconductor Index from the beginning of the year has reached 37%. Dolphin Analyst believes that the reasons for the frequent decline in the semiconductor index over the past year are:

① The impact of the Fed's interest rate hikes;

② The impact of the downward cycle of the semiconductor industry.

Source: LONGPORT

Setting aside the impact of the macro environment, this article mainly focuses on the situation in the semiconductor industry and explores three questions: What is the reason for the downturn in the semiconductor industry? What is the current situation of the semiconductor industry chain? Does the semiconductor industry have investment value?

Through analysis of semiconductor industry and company data, Dolphin Analyst believes that the main cause of this round of semiconductor decline is the weak downstream demand, but there is no obvious sign of improvement in the semiconductor industry chain from the latest financial reports.

Since stock prices reflect expectations and often precede the recovery of the industry, although the current situation is still in a downward cycle, there is no harm in making early arrangements. The most important thing at this time is to select stocks and directions.

Dolphin Analyst believes that the rise in panel prices and the drop in Xiaomi's inventory mean that the panel industry and Android phones may be the first to see a bottoming out. Apple's mobile phones may have a certain downward risk this season due to factors such as the epidemic. With the high inventory backlog in various links of the industry going away, the industry is expected to return to its normal shipping pace, and valuations are expected to recover from the current low level. The low base of the past year has laid a good foundation for growth in the next year.

Dolphin Analyst has previously issued a signal about the rebound of panels and Xiaomi, and will continue to track the inventory digestion of the semiconductor industry and seize the opportunity of "reverse of the dilemma" of the semiconductor industry chain.

The following is Dolphin Analyst's analysis of the current semiconductor industry:

I. What is the reason for the downturn in the semiconductor industry?

Dolphin Analyst and everyone will find the reason for the decline in the semiconductor industry from the perspective of the industrial chain. Since semiconductors are mainly used in electronic products after they are manufactured, research on the semiconductor industry should start from two aspects: the semiconductor industry chain and the electronic industry chain.

The reason for this round of semiconductor downturn is still due to the weak downstream demand for products, which is transmitted through the industrial chain to the entire semiconductor industry:

① Electronic industry chain: Electronic products (weak terminal consumption such as mobile phones, PCs) -> Inventory backlog of electronic manufacturers -> High inventory reduces the driving force from chip companies;

② Semiconductor industry chain: Chip companies' orders decrease -> Reduce wafer flow in semiconductor manufacturing plants -> Semiconductor manufacturing plants' capacity utilization rate declines and begin to reduce capital expenditures of the company. Therefore, the current downward trend in the semiconductor cycle is mainly due to insufficient demand for downstream electronic products. According to IC Insights data, computer and mobile communication products are the largest downstream of the semiconductor industry, accounting for more than 70% of overall demand. The prosperity of the semiconductor industry is closely related to these two downstream industries.

1) Computer products-PC market: continued decline

Global PC shipments reached only 74.25 million units in the third quarter of 2022, down 14.3% year-on-year. The continued decline in PC shipments since the beginning of 2022 has reduced the demand for computer-related chips. The prices of chips such as graphics cards and storage have also frequently fallen.

After the demand for home-based economy brought about by the epidemic subsided, the decline in PC shipments from its peak caused a push for the current downward trend in the semiconductor cycle.

2) Communication products- smart phone market: continued decline

Coincidentally, global smartphone shipments in the latest quarter were only 300 million units, down 8.8% year-on-year. Affected by unstable factors such as the epidemic and insufficient product innovation, consumers have reduced their purchases of smartphones. As an important downstream of the semiconductor industry, the sluggish demand has also prompted the semiconductor industry to enter a downward cycle.

Although the development of new areas such as smart cars and VR devices has brought new market increments to the semiconductor industry. However, smart phones and computers still have the largest share of the current semiconductor market, and the weakness in these two fields directly weakens the demand for semiconductor chips.

When smartphones and computers are not selling, downstream manufacturers have high inventories, decreasing the inventory of semiconductor chips. As chip companies' orders decrease, their flow through semiconductor manufacturing plants decreases, resulting in an overall downturn in the semiconductor industry chain.

II. How are the current companies in the semiconductor industry chain (design/ manufacturing/equipment) performing?

Since the current downward trend in the semiconductor industry is caused by weak downstream demand, how are companies at each stage in the semiconductor industry chain performing and are there any signs of recovery?

2.1 Semiconductor design (Qualcomm, NVIDIA, AMD)

From the perspective of industry chain transmission, insufficient downstream terminal demand is first transmitted to chip companies. Dolphin Analyst has selected Nvidia, Qualcomm and AMD to see the current situation of semiconductor design. Nvidia and Chia Tai Semiconductor's downstream mainly serve the computer industry, while Qualcomm's downstream mainly serves the smartphone industry. ①Revenue end: The revenue growth rates of Nvidia, Qualcomm, and$AMD(AMD.US) all declined this quarter, especially Nvidia, which saw a double-digit year-on-year decline in revenue this quarter. This indicates that the weakness in the downstream end market has affected the revenue of the three chip companies.

Considering the decline in the PC market mentioned earlier, the revenue growth rates of Nvidia and$AMD(AMD.US) have also decreased significantly since Q2 2022, which coincides with the trend of PC shipments.

②Inventory end: The inventory turnover days of Nvidia, Qualcomm, and$AMD(AMD.US) continued to increase this quarter, and the push from downstream demand for goods has not yet significantly improved. In fact, the inventory turnover days of the three companies started to increase at the end of 2021 based on the trend. Among them, the inventory turnover of Super Micro was affected to some extent as it acquired Xilinx in the year. The rising inventory actually implies a risk of pressure on the company's future revenue end, which began to emerge in Q2 2022.

2.2 Semiconductor Manufacturing (TSMC, SMIC, HHMC)

The upstream of semiconductor design is the semiconductor manufacturing link. The rise of inventory affects the ordering situation in chip factories. Dolphin Analyst selected TSMC, SMIC, and HHMC to see the current situation of semiconductor manufacturing.

①Revenue end: TSMC.US, SMIC and HHMC all showed further slowdown in revenue growth this quarter, affected by the weakening of chip design company's chip tape-out demand. Previously, the shortage of semiconductor supply had led to a continuous increase in chip prices, thereby promoting revenue growth. However, in Q2 2022, the semiconductor industry started to peak, and the revenue growth rates of the three companies began to decline.

②Inventory end: The inventory turnover days of TSMC, SMIC, and HHMC continued to increase in this quarter. Judging from the inventory reflected by downstream feedback, there is no obvious sign of digestion. From the trend, the inventory turnover days of the three companies have accelerated since Q2 2022. TSMC has its own characteristics, and the release of new products by major customers has some digestive effect.

2.3 Semiconductor Equipment Link (Applied Materials, Lam Research, KLA)

The utilization rate of semiconductor manufacturing capacity affects the overall capital expenditure planning of the company, and subsequently affects the operating conditions of semiconductor manufacturing companies. Dolphin Analyst selected Applied Materials.US, Lam Research, ASML, and SMIC to look at the current situation of the semiconductor equipment industry.

①Revenue end: The revenue of Applied Materials, Lam Research.US, and KLA.US has not declined, but the growth rate has decreased compared to the same period last year. As for ASML's products, they have their own special characteristics, and regional friction directly affects the company's revenue situation.

Semiconductor equipment companies still have relatively high growth rates, mainly because the impact of semiconductor companies' downward adjustment of capital expenditures has not yet manifested in the first three quarters. Therefore, there is a lag in transmission in the industry chain. Although semiconductor equipment companies still have double-digit growth at present, there is a certain risk of downstream capital expenditure reduction in the future.

②Inventory end: The inventory turnover of Applied Materials, Lam Research, ASML, and SMIC has slowed down, but it is still slowly improving. In comparison, although semiconductor equipment companies' revenue is still growing fast, the inventory end is also beginning to slow down. Therefore, it can be seen that the semiconductor equipment industry may also be affected by the industry downturn in the future.

Based on the overall situation of the semiconductor industry chain (design-manufacturing-equipment), Dolphin Analyst found that the downstream demand slump caused by the semiconductor cycle downturn has been reflected in the design and manufacturing links, and the risk in the equipment link is still unclear. At present, companies like Micron and TSMC have already lowered their capital expenditure plans, which will inevitably have an impact on the performance of semiconductor equipment companies. As the inventory situation continues to deteriorate, chip design companies may prioritize inventory impairment/reduction sales operations. In the semiconductor industry chain, design companies will react to market conditions first because they directly face downstream electronics manufacturers.

3. Is the semiconductor industry worth investing in?

Looking at the design, manufacturing, and equipment links in the semiconductor industry, there is no obvious sign of improvement, and Dolphin Analyst believes that the current semiconductor industry is still in a downward trend. Although the semiconductor industry is still in decline, after experiencing this year's decline, the value of investing in the semiconductor industry is gradually becoming evident. The semiconductor industry is still in the left-hand area, but stock prices tend to reflect expectations and often lead the industry. And at present, priority should be given to:

1) The main direction of the semiconductor industry: the mid-to-long-term trend of semiconductor localization. Semiconductor is currently a key direction of technological competition, which involves multiple aspects such as social life, military strength, etc. However, the proportion of domestic semiconductor chip production is less than 20% at present, which is an important link in the road to localization. Even under the influence of the industry, there is still a long-term opportunity for the industry in the future, despite the significant pullback in 2022.

(2) Industry situation of the semiconductor sector: Signs of recovery in some downstream areas. Affected by weak downstream demand for the whole year of 2022, the semiconductor industry frequently fell. However, after experiencing the downturn of the industry, there are signs of bottoming out recovery in some downstream industries.

(1) Panels are the most vulnerable: After falling below the cash cost, the panel price finally began to rise at the end of the year. Although there was no significant boost in demand for televisions, the price competition on the supply side changed the original supply-demand relationship as the capacity utilization rate was adjusted downwards.

(2) Android phone inventory began to digest: Xiaomi-W.HK, OPPO, and VIVO's phone shipments have frequently fallen by more than 20% before, and demand has not seen any obvious improvement. Taking Xiaomi as an example, under the strategy of "de-stocking", the inventory of this quarter finally showed a significant decrease. As inventory levels return to normal, Android brand phones are expected to resume shipping.

(3) Beware of Apple's supply chain risks: Although Apple.US still delivered a growth against the trend in the third quarter, it's also difficult to conceal the risks in the fourth quarter. Firstly, the release of the iPhone 14 series of phones did not sell particularly well, with an overall "purchase to delivery" time comparable to last year. Then, Apple's main suppliers of phones were affected by the epidemic, and the supply side was affected to some extent. Therefore, Apple's phone shipments this quarter may show a year-on-year decline, thereby dragging down Apple and its industrial chain.

(4) Continue to focus on stocking trends: The overall bottoming out of the industry still requires attention to the inventory de-stocking situation in the industry chain. Although we see panel prices rising and Android inventory de-stocking at present, downstream demand is still not strong. The current recovery is more of a localized repair. To see a full recovery in demand, it is necessary to closely track end shipments and inventories at all levels.

(3) Valuation situation: Looking at the Philadelphia Semiconductor Index, after the decline of this year, the valuation level of the semiconductor industry has been continuously decreasing. It has now dropped to 17.83, far below the median valuation. Affected by macroeconomic interest rate hikes and industry downturns, the overall valuation of the industry is under pressure. The domestic semiconductor index has also dropped below the median for the past five years. However, Dolphin Analyst believes that when the industry begins to bottom out and risks are gradually released, the industry is expected to return to a slightly lower valuation.

Source: Wind, Dolphin Investment Research

Through the sorting of the semiconductor industry chain, Dolphin Analyst believes that the current semiconductor industry is still in a downward cycle, and there is no obvious sign of recovery in the financial reports of most semiconductor leading companies. However, as stock prices reflect expectations, they often take precedence over the recovery of the industry. At the current position on the left-hand side, it is more important to select individual stocks and directions. Dolphin Analyst believes that the panel industry and Android phones may bottom out first, while there may be some downside risk for Apple phones this quarter. With the high inventory backlog in various links in the industry being cleared, the industry is expected to return to normal shipping pace, and valuations are expected to recover from their current low levels. The low base of the past year has laid a good foundation for next year's growth.