Why is there a wave of smartphone upgrades? Goldman Sachs has given a new reason.

The pain of the three-year adjustment in the smartphone industry seems to be coming to an end.

On November 23rd, according to data released by market research firm Counterpoint Research, global smartphone sales in October increased by 5% compared to the same period last year. This is the first month-on-month increase in sales since June 2021 and also sets a new record for monthly sales since January 2022. Previously, global smartphone sales had been declining year-on-year for 27 consecutive months.

Analysts from Morgan Stanley, including Meng Yu, recently raised their forecast for smartphone shipment growth in 2024 from 2.7% to 3.9%, and for 2025 from 4.3% to 4.4%.

Analysts pointed out that edge AI will become the next trend, driving the smartphone market into a new product cycle. At the same time, factors such as the end of destocking, a surge in urgent orders, and Huawei's return to the market are expected to bring about a cyclical recovery in the smartphone industry.

Early positive signals indicate that industry recovery is imminent

The bank stated that the market is currently generally pessimistic about the smartphone market, mainly because of the lessons learned from the PC market. There are concerns that smartphones will experience a multi-year downturn cycle similar to PCs due to a lack of new features, longer replacement cycles, market saturation, and consumer sensitivity to macroeconomic indicators, especially inflation and disposable income.

However, Morgan Stanley pointed out that based on early signals, the smartphone market is emerging from its trough and inventory pressure has been largely released:

This round of destocking began in the second quarter of 2022 when smartphone manufacturers reduced production. With destocking largely completed, smartphone manufacturers will arrange production based on spot market demand and are unlikely to face intensified inventory pressure.

We have also observed a surge in urgent orders for components in the third quarter of 2023. This is mainly due to most smartphone manufacturers continuing to adopt conservative inventory strategies and only placing orders when demand is strong or inventory is scarce. The increase in temporary orders in the supply chain indicates tight finished product inventory and better-than-expected demand for some products. We believe this is an early signal of industry recovery.

In terms of shipments, global smartphone shipments have steadily declined since the first quarter of 2022, with a 9% decline in the first quarter of 2022, an 18% decline in the fourth quarter of 2022, and a narrowing decline to 7% in the second quarter of 2023, indicating that the market is gradually returning to its cyclical mean. The narrowing decline in year-on-year growth also indicates that the market is emerging from its trough and is expected to show year-on-year growth (recovery) in the coming quarters.

The smartphone market is different from PCs

Regarding concerns that the smartphone market will stagnate for years like PCs, analysts pointed out that the growth trajectory of smartphones is unique and will not follow the same path as PCs. Analysts believe that the differences between the two products are significant and will drive the recovery of the smartphone market, leading to a revival before 2025. First of all, the decline in PC sales is not only cyclical but also a result of demand being diluted by smartphones. However, currently, there is no technology product that can compete with smartphones.

Competition may eventually come from AR/VR or other technologies, but it is unlikely to happen in the short term. In 2022, the sales volume of AR/VR devices is only 9 million units, far below the 494 million units of smartphones sold in 2011 when they first became popular.

Secondly, smartphones have higher usage frequency and smaller battery capacity, so they are usually replaced faster than computers.

Due to the frequent use and small battery capacity of smartphones, the replacement frequency is higher than that of personal computers. The usage frequency of smartphones continues to rise, with the proportion of daily internet usage on mobile devices increasing from 27.3% in 2013 to 56.9% in 2022, and it is possible to reach 64.9% in the next 5-10 years.

Therefore, with the improvement of the macroeconomic situation, consumers will prioritize purchasing new smartphones rather than personal computers.

Edge AI will usher in a new product cycle starting in 2025

Goldman Sachs also pointed out that this year's AI wave has made many smartphone manufacturers feel a sense of urgency and started to focus on research and development of edge AI.

Edge AI refers to the execution of artificial intelligence tasks on the edge of devices or systems (such as smartphones and personal computers), rather than relying entirely on data centers. Currently, most AI functions can only be used in the cloud.

Analysts believe that ChatGPT has provided many possibilities for AI development. Although most AI functions can only be used in the cloud at present, the launch of edge AI next year will bring new application scenarios for smartphones and personal computers, including:

1. Professional-level photography
2. Desktop-level games on smartphones
3. Always-on sensing cameras
4. AI drawing software Stable Diffusion
5. Smarter voice assistants
6. AI smartphones as virtual companions

In the recovery cycle, smartphone manufacturers may introduce new edge AI functions, benefiting supply chain companies. Among suppliers, we expect chip and memory suppliers to benefit more as drivers of edge AI than other smartphone component suppliers such as display screens, cameras, RF/power management chips, and MLCC.

For the PC supply chain, chip replenishment has already been completed, while smartphone replenishment has just begun. As for the Android and Apple supply chains, given that Android phone shipments in 2022 have declined more significantly, we believe that the performance of the Android supply chain will be better, and we expect Huawei's return to intensify market competition.

We believe that starting from 2025, AI applications will lead the next cycle of product development for smartphones and personal computers, which will be a key catalyst for stock value reassessment.

Considering the positive impact of edge AI, Goldman Sachs has chosen to raise its forecast for global smartphone shipments in 2025. The bank also predicts that as the smartphone market continues to recover:

1. The performance of smartphone supply chain stocks will outperform smartphone manufacturers. As promoters of edge AI, memory and SoC suppliers are expected to stand out in terms of stock performance.

2. Smartphone suppliers will outperform personal computer suppliers, as PC chip replenishment has ended while smartphone replenishment is just beginning.

3. The performance of the Android supply chain will be better than that of Apple suppliers. In 2022, Android phone shipments declined by 13%, while Apple phone shipments only declined by 4%. Additionally, Huawei's return will increase competitive pressure among industry peers.