RNECF - Renesas: The Automotive Market Could Giveth And Then Taketh Away

2023-12-26 06:02:26 ET

Summary

• RNECF has managed to outperform most semis in what has been a challenging year thanks to resilient demand for automotive chips.
• The automotive chip market grew at a time when the semiconductor market shrank, but there are increasing signs this could be headed for change.
• The automotive market is undergoing changes, which present opportunities for RNECF to take advantage of, but also challenges.
• RNECF has been held up by a tailwind, but this tailwind may start to falter due to changes that are making their presence felt.

There are still a few days left, but Renesas Electronics Corporation (RNECF) has not done badly in 2023 considering the circumstances. FY2023 revenue, for instance, is projected to end up slightly down YoY, which is better than many other semis and the industry as a whole. This after a record-breaking year in FY2022. This resilience was in large part the result of a market for automotive chips that was able to grow at a time when most market segments shrank due to a decline in demand for most types of semiconductor chips. However, the automotive segment is confronted with a number of challenges heading into 2024, which raises questions as to how long the automotive market can remain a tailwind for RNECF. Why will be covered next.

The automotive market has become increasingly important to RNECF

RNECF was founded in 2002, but its roots go back even further in time. RNECF is essentially the result of a merger between the semiconductor arms of several Japanese companies, including Hitachi, Mitsubishi and NEC. Among other things, RNECF is considered the world's largest suppliers of MCUs, which it supplies to a wide range of markets.

In recent years, the automotive market has increased in importance, especially with the emergence of electrical vehicles or EVs, which, depending on the model, tend to incorporate far more chip content compared to previous-generation vehicles with an internal combustion engine. The list of products supplied by RNECF include automotive-grade MCUs, sensors and so on.

In FY2022, for instance, the automotive segment accounted for 43% of revenue at RNECF, way ahead of IoT with 28%, Industrial with 17% and Infra with 11%. In the most recent or Q3 FY2023 report, total revenue declined by 2.1% YoY to JPY379.4B as shown below, which equals $2.67B using a USD:JPY exchange rate of 1:142.

But a closer look reveals divergence. Automotive contributed JPY176.3B, an increase of 11.7% YoY, but IoT/Industrial/Infra contributed JPY200.7B, a decline of 11.5% YoY. In the first three quarters of FY2023, automotive contributed JPY514B, which exceeds the JPY475.5B automotive contributed in Q1-Q3 FY2022. Automotive thus came to the rescue.

Source: RNECF

The automotive segment has outperformed in what has been a down year for RNECF. Nevertheless, there is a slowdown underway. The forecast calls for Q4 FY2023 revenue of JPY358B at the midpoint, down QoQ and YoY. FY2022 revenue was JPY1,502.7B, but FY2023 revenue is forecast to be JPY1,465.8B, a decline of 2.5% YoY. From the Q3 earnings call:

"So this will be the fourth quarter and full year forecast. In terms of the fourth quarter, this is in the middle, dark blue column. In terms of revenue, the medium value, JPY358 billion, year-over-year, it's a minus 8.5%, quarter-over-quarter, it's minus 5.6%. If we exclude the foreign exchange impact, going below the line, it's minus 8.2% year-over-year and minus 6.8%, quarter-over-quarter. In terms of the gross margin, it's 56.3%, operating margin, 30.5%.

In terms of the gross margin, quarter-over-quarter, it's minus 1.9 percentage points. The major reason behind this is that the worsening, slight worsening of the product mix, the utilization decline through the production adjustment and the increase of the production cost. So in terms of the operating margin, it's minus 4.4% Q-on-Q. That is through the [concentration] of OpEx at the term end. In terms of R&D, SG&A, it's going to increase in the fourth quarter. For the full year forecast, please refer to the three lines beyond that. In terms of the revenue, JPY1,465.8 billion, gross margin, 56.9%, operating margin, 33.8%. That is our forecast."

A transcript of the Q3 FY2023 earnings call can be found here .

Still, most semis are worse off than RNECF. The general expectation is that the semiconductor market will end up contracting in the low teens by the time 2023 is done. In contrast, RNECF could top that number by about 10 percentage points. So if not for the automotive market, things could have been significantly worse for RNECF.

The state of the automotive market heading into 2024

As mentioned earlier, chip content has been on the rise in vehicles and this is expected to continue in the coming years, especially as passenger cars are increasingly equipped with new features, including advanced driver assistance systems or ADAS, which could one day lead to fully autonomous vehicles. All these features require more semiconductor chips. As a result, the market for automotive chips has grown significantly.

For instance, according to some reports , the market for automotive chips was valued at $45.2B in 2022 and it is forecast to grow to $50.7B in 2023, which is roughly three times what it was five years before. It also comes at a time when the overall market for semiconductor chips is down. The market is forecast to grow at a CAGR of 12.27% to $128.08B in 2023-2032. This bodes well for RNECF, but keep in mind there are competitors out there, including Infineon, ROHM and others, all of whom would undoubtedly like a share of the pie.

Potential headwinds facing the market

However, there are headwinds out there that seem to be gaining strength. Keep in mind that while the market for automotive chips has grown, the automotive market itself has shown much less vigor in terms of unit sales. Car sales totaled 81M units in 2022, which is down from 95.3M units five years earlier in 2017. Most forecasts expect the market to grow in the low to mid single digits in 2023.

The automotive market has yet to fully recover from the post-COVID-19 dip. The automotive chip market has overcome this drop in car sales with the move towards increased electrification in vehicles, particularly in China where EVs, both BEV and PHEV, are expected to reach 30% or more of unit sales in 2023.

But there are increasing signs the EV market is slowing down. EV sales did not grow as fast in 2023 as they did in 2020-2022. EVs accounted for about 4% of total car sales in 2020, which increased to about 14% in 2022. It is expected to reach about 16% in 2023. This apparent slowdown has manifested itself in many different areas.

For instance, there are reports of growing inventories of unsold EVs at car dealers in the U.S. A number of automakers like Ford ( F ) have scaled back their investment plans due to a weakening in demand. Others like Tesla ( TSLA ) are cutting prices to boost slowing unit sales. Various reasons have been cited as leading to the slowdown, including the higher cost of EVs versus ICE vehicles, range anxiety due to a lack of charging infrastructure, safety issues due to lithium-ion batteries being perceived as a fire hazard, and so on.

How automotive could become a drag for RNECF

A faltering market for EVs would be a headwind for RNECF since it could lead to less demand for the types of chips it tends to specialize in. In addition, there may be changes underway that could work against RNECF in China, a country that ranks number one in terms of car sales and a country that contributed JPY424,150M or 28.3% to FY2022 revenue of JPY1,500,853M according the most recent annual report .

Yet there seems to be a shift underway in China with local carmakers giving preference to domestic suppliers of automotive chips. There are reports the government in China has urged automakers to use local suppliers. In turn, Chinese automakers are increasing their investment in local chip manufacturing to boost the supply of domestic chips. A breakdown of Q3's revenue shows that this may be having an impact on RNECF. Of all the end markets, China was the weakest with a decline of 15.8% YoY to JPY94,486M as shown below.

Source: RNECF

The decline in RNECF sales in China stands in contrast to the increase in production and sales of new energy vehicles in China, According to CAAM, the vehicle market will grow by 11.7% YoY to reach around 30M units. In terms of new energy vehicles, including EVs, growth is even better at 36.5% to 9.4M units. In fact, China is expected to overtake Japan to become the number one car exporter in 2023.

These numbers suggest there are a few worrying trends underway for RNECF. Sales in China are decreasing even though the market there is growing, which implies loss of market share for RNECF. This could become troublesome if China continues to make headway in the EV market, where it is increasingly in the lead at the expense of automakers in say Japan.

If the worldwide automarket becomes dominated by Chinese brands, then it is not hard to see how this could become a headwind for RNECF when these carmakers prefer to use local semiconductor chips. RNECF would lose out by not only not supplying the Chinese carmakers, but also by having its non-Chinese customers, particularly those in Japan, lose market share to the aforementioned carmakers.

Investor takeaways

While RNECF can be said to have outperformed in what has been a challenging year for the industry, thanks to resilient demand for automotive chips, there is reason to believe that tailwind is at risk of losing its potency and may even turn into a headwind in the worst case.

The EV market has grown tremendously in the last several years and many industry forecasts have extrapolated recent growth by assuming growth in the coming years would be similar to those in the past. However, that assumption may have been premature since it is possible that growth may not be as fast in the coming years.

It's possible the EV market has already reaped the low-hanging fruits. Those who wanted an EV may have already switched as soon as they became available. What remains are those who are not as enthusiastic about EVs for whatever reason, whether cost or something else. If this is true, then it stands to reason that growth in the EV market may not resemble that of recent years. Further growth could be harder to come by.

This could explain the recent signs of a slowdown in the EV market. Carmakers will need to compete harder with more competitive products since consumers who have yet to own an EV may need more enticement to convince them of the need for an EV. This implies increased competition for everybody involved in the making of an EV, which includes a supplier like RNECF.

It also comes at a bad time for RNECF since it is the automotive segment that has been giving the quarterly results a lift. If not for growth in automotive chips offsetting contraction elsewhere, the recent results would have been worse. The automotive chip market has so far avoided the slump that has hit other segments of the semiconductor market, but that may not last.

In addition, while China has greatly boosted the EV market in recent years, which has helped RNECF, change may be underway. There seems to be a concerted effort underway to replace products supplied by foreign vendors like RNECF with those from domestic suppliers. This would not only affect RNECF in China, but also in other markets, depending on how much traction Chinese automakers gain in the global market for cars. The recent projections that China will seize the title of top car exporter this year from Japan, on top of being the largest market of cars, is not a good sign for RNECF.

So while RNECF has done well in a challenging 2023, I am neutral on RNECF. The automotive market has made the difference for RNECF, but there is reason to believe it will not last. RNECF has outperformed, but it could start to underperform in the near future, depending on how EV demand evolves and what happens in China.

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