Citi: Don't panic over the sharp drop in chip stocks, now is a good buying opportunity

In this wave of market turbulence, chip stocks at high levels have suffered heavy losses. Citigroup believes that there is no need to panic about the sharp decline, as the demand for AI and memory markets is strong, making it a good buying opportunity now.

In the semiconductor industry report on August 8th, Citigroup pointed out that although chip stocks experienced a significant decline in the second quarter of 2024, this was mainly caused by macroeconomic factors and high expectations:

Due to the negative performance of companies such as Intel, Micron Technology, and NXP Semiconductors, there was a general expectation of an 11% decline in earnings per share in this financial quarter, with an average quarter-on-quarter decline of about 5%. In addition, the restocking of analog chips did not happen as quickly as expected, and the risk in the automotive terminal market (which accounts for 14% of semiconductor demand) is increasing.

Despite the underperformance of some companies, Citigroup remains optimistic about the semiconductor market, mainly because of the strong demand in AI and storage markets:

Due to reduced production capacity, the price of DRAM in the third quarter is better than expected, and the upward price trend is expected to continue. Micron is our top pick, and we believe it is time to double down now.

Selling off is the result of macro factors and high expectations

Citigroup believes that this sell-off is a combination of macro factors, high expectations in the semiconductor industry, and disappointing performance:

• Overly high expectations: The price-to-earnings ratio of the U.S. Semiconductor Index (SOX) is 37 times, with a 70% premium over the S&P 500, the highest level since 2008.

• Disappointing performance: Consensus earnings per share (EPS) expectations have dropped by 11%, mainly due to the performance decline of Intel, Micron Technology, and NXP Semiconductors. ASML did not meet expectations due to restructuring, and Intel has cut its capital expenditure for 2025 by 25%.

• Analog chip restocking has not occurred: Sales expectations for analog companies, except for Texas Instruments, have been revised downward.

• Continued soft demand in industrial and automotive terminal markets: Sales in the automotive terminal market have only dropped by 13% from the peak, much lower than the 30%-40% decline in the industrial terminal market. We believe that sales in the industrial terminal market are bottoming out, but the decline in the automotive terminal market may be even greater.

Strong demand in AI and storage markets

Nevertheless, Citigroup remains bullish on the semiconductor sector, especially due to the strong demand in AI and storage markets. In its report, it optimistically points out:

1. Strong demand in AI and storage markets: AI and storage markets account for 30% of semiconductor demand, and their fundamentals remain strong. AI capital expenditures are increasing, with Meta and Microsoft expected to achieve significant growth in capital expenditures by 2025; DRAM prices are expected to rise by around 15% in the third quarter of 2024, higher than the expected low double-digit growth. The DRAM market continues to improve, and we expect DRAM prices to increase by 62% year-on-year in 2024The reason is limited supply growth, as well as memory manufacturers allocating capacity to HBM. We expect Micron to provide an upward guidance when announcing earnings in September.

1. Stable demand in PC, data center, and mobile phone markets: Although the automotive/industrial terminal markets still appear soft, the demand trends in the three major terminal markets of PC, mobile phones, and servers (which together account for 61% of demand) are relatively healthy. Micron stated that the inventory in the traditional data center market improved in the first half of the year and is expected to grow in the second half. During AMD's second-quarter earnings conference call, they saw healthy demand signals for general computing in client and server businesses. According to comments from Texas Instruments, STMicroelectronics, and NXP Semiconductors, the communication infrastructure terminal market (accounting for 4% of half-way demand) seems to be rebounding from its low point.

Citi expects semiconductor sales growth to reach 14% in 2024, with sales reaching $603.2 billion. Unit shipments are expected to increase by 3% year-on-year, and the average selling price is expected to increase by 13% year-on-year.

In addition, Citi also points out that given the recent sell-off, it is time to double down on Micron and other companies, as their bet is based on the oligopoly monopoly, and the DRAM market will continue to be tight.