2023-05-24 10:00:00 ET
Summary
- We continue to be sell-rated on GlobalFoundries as we continue to see headwinds in 2H23.
- Consistent with our expectations, GFS revenue growth decelerated in 1Q23, dropping 5% Y/Y and 12% sequentially as ASP increases didn’t offset weaker unit demand, especially in the mobile market.
- While we believe smartphone-related sales will recover seasonally in 2H23, we believe end-market demand remains lackluster; thus, we don't expect to see a true sustained recovery for its mobile-related business.
- Additionally, demand from the data center and communications infrastructure markets has now started to weaken.
- We continue to recommend investors avoid GFS, as we expect it to underperform its peer group through 2H23.
We maintain our sell rating on GlobalFoundries ( GFS ) post-1Q23 earnings results, as we expect the stock to continue underperforming the advanced foundry peer group in 2H23. The stock is up roughly 5% since our sell rating in November, underperforming the S&P 500 by 8% and SOX by 23%. Consistent with our expectations in our last note , GFS revenue growth decelerated this quarter , dropping 5.2% Y/Y and 12% sequentially to $1.84B compared to revenue growth of 13.5% Y/Y to $2.1B in 4Q22 and revenue growth of 23.5% Y/Y in 3Q22 . GFS's revenue growth has been decelerating since 3Q22, as revenue growth was supported by ASP increases that could not offset weaker unit demand this quarter. GFS CEO Thomas Caulfield highlighted the lower revenue growth expectation in the 1Q23 earnings call , saying, "We are now anticipating that revenue will decline year-over-year in the mid to high-single-digit percentage range." While we have not seen aggressive price contraction in the foundry industry, we see a higher risk profile to GFS's near-term gross margin performance as the foundry industry orders lead times contracts. GFS reported a gross margin of 28% this quarter, down from 29.6% a quarter ago.
The following chart outlines our rating history on GFS.
Looking ahead, we believe the company will continue facing headwinds in 2H23, primarily from mobile end-market demand. GFS's Smart Mobile Devices segment accounted for 38% of total sales this quarter, down from 50% a year ago. We're more constructive on smartphone-related sales recovering seasonally in 2H23 but believe end-market demand will remain weak due to macro headwinds and inflationary pressures. GFS's Smart Mobile Devices revenue is down 15% sequentially and 29% Y/Y to $696M. We forecast the smartphone total addressable market or TAM to shrink by around 2.5% this year compared to 2022; the global smartphone market declined 14.6% Y/Y and 7% sequentially in 1Q23, according to IDC which was worse than IDC's previously forecasted 12.7% drop. We believe macro headwinds will continue pressuring GFS's primary revenue stream, and hence, expect the company to underperform in 2H23. We recommend investors not get caught in the rosy talk about "resilient financial performance" and explore exit points at current levels.
No offsetting weaker demand environment in 2H23
While GFS is primarily exposed to the smartphone market, it's also exposed to the data center, communications infrastructure, automotive and PC demand, and the weight of these segments in the company's revenue mix by end-market has increased over the past year. Still, we don't believe data center, communications infrastructure, automotive and PC demand will offset macro headwinds weighing down revenue. In fact, we believe demand from data center and communications infrastructure to have begun weakening due to softer cloud/enterprise spending amid market uncertainty. GFS's Communications Infrastructure & Data Center segment, accounting for 19% of total sales this quarter, is down 9% sequentially despite being up 8% Y/Y. IDC lowered its 2023 forecast for worldwide IT spending in April for the fifth consecutive quarter; we expect the tighter spending environment to limit meaningful demand growth in 2H23 in communications infrastructure and data center markets. Intel's ( INTC ) Data Center and AI Group revenue was down 39% Y/Y in 1Q23 due to TAM contraction in the market and competitive pressure. Advanced Micro Devices ( AMD ) also reported flat Y/Y growth in its Data Center segment this quarter. Hence, we expect GFS to also feel the softer demand in data center markets in 2H23.
The following table outlines GFS's revenue by end-market in 1Q23.
The PC market is stuck in a slump, evidently from INTC and AMD's PC TAM forecasts this year. GFS's PC revenue dropped 69% sequentially and 12% Y/Y. Automotive seems to be a bright spot on many earning calls in the semi-space this quarter; GFS's automotive segment was the only positive end-market revenue growth this quarter, up an impressive 57% sequentially and 122% Y/Y. GFS is growing its automotive portfolio, noting in the earnings call new power management products with expanded voltage handling capabilities on the 130 BCDLite product line. We expect healthy demand levels in the automotive segment this year compared to 2022. Still, we don't expect automotive revenue growth to offset macro headwinds pressuring GFS's other revenue streams, namely its mobile segment. We continue to see a grim outlook for the stock in 2H23 and recommend investors avoid GFS in the near term.
Valuation
GFS is fairly valued, but we see the stock underperforming in 2H23 and 2024. On a P/E basis, the stock is trading at 26.4x C2023 EPS $2.16 compared to the peer group average of 25.5x. The stock is trading at 4.1x EV/C2023 sales versus the peer group average of 5.5x.
The following chart outlines GFS's valuation against the peer group.
Word on Wall Street
Wall Street doesn't share our bearish sentiment on the stock. In fact, out of the 15 analysts covering the stock, 12 are buy-rated, two are hold-rated, and the remaining are sell-rated. We attribute Wall Street's bullish sentiment on the stock to GFS's revenue growth in FY2022 despite the semi industry's downturn, which we believe was largely driven by unsustainable ASP hikes that cannot offset weaker unit demand in FY2023. The stock is trading at $57 per share. The median sell-side price target is $71, while the mean is $72, with a potential 25-27% upside.
The following chart outlines GFS's sell-side ratings and price targets.
Tech Stock Pros
What to do with the stock
We continue to be sell rated on GFS's stock. Our investment thesis regarding revenue growth decelerating has played out, and now we see macro headwinds in the mobile market pressuring the company in 2H23. We expect the company to underperform in 2H23 due to weaker-than-expect mobile end-market demand as well as now weakening data center and communications infrastructure demand. The stock is trading roughly 37% higher than its 52-week-low of $36.80. We see favorable exit points at current levels and recommend investors take the exit route as we see limited growth for GFS in 2H23.
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For further details see:
GlobalFoundries To Underperform In H2 2023 Due To Macro Headwinds