2023-03-07 18:03:43 ET
Summary
- Infineon's fiscal first quarter was a bit light on revenue, but better on margins, and guidance for the next quarter was strong relative to many chip companies.
- Auto demand looks healthy for 2023, as auto microcontrollers are sold out and demand for EV powertrain and ADAS chips is strong.
- Weakness in consumer markets is a known issue now, but emerging weakness in industrial markets (drives in particular) is something to watch.
- Infineon looks like a classic "short-term versus long-term" debate, with elevated risk in the short term from pricing, weaker orders, and so on, but a strong long-term outlook.
- Long-term revenue and FCF growth in the high-single-digit to low-double-digits can support a fair value roughly 20% higher than today's price.
I can't really complain about the performance of Infineon ( IFNNY ) since my last write-up on this diversified European semiconductor company. Up about 25%, Infineon stock has outperformed the broader semiconductor market (as measured by the SOX index), keeping pace with STMicroelectronics ( STM ), while some stocks (like ON Semiconductor ( ON )) have done even better. Infineon has continued to benefit from its broad leadership in power and auto semiconductors, with significant benefits coming from pricing given industry supply constraints (particularly in microcontrollers, or MCUs, for auto customers).
Assessing the stock today is a little tricky. I'm definitely bullish on the long-term prospects for this company, as I like its multi-market and multi-technology exposure to growing power semiconductor demand. I also like arguably underappreciated leverage to IoT, sensing, and MEMS devices. What I don't like is that the company's end markets could still be looking at a sharper correction than what is reflected in sell-side estimates, as pricing has yet to really correct in many of its end markets and some markets (like industrial drives) appear to be weakening.
If you're the type of investor who can buy a stock as a longer-term holding, see it decline 15% shortly thereafter, and not really be bothered by second-guessing the fact you could have bought in even lower, then I think the long-term potential of Infineon makes this a name to consider. If you find the idea of a short-term loss harder to stomach and you're willing to risk buying at a higher price (or not buying at all) in pursuit of a lower entry point, you may want to hold off.
A Quick Quarterly Review
Infineon reported fiscal first quarter results about a month ago, and those results showed a continuation of recent trends - strong auto and renewables demand, still-healthy industrial markets, but some cracks in data center and telecom, and ongoing weakness in consumer markets.
Revenue rose 25% year over year and declined 5% quarter over quarter, missing by a trivial 1%. The Automotive (or ATV) business reported 35% year-over-year growth and a 3% sequential contraction, Industrial Power Control (or IPC) reported 31% yoy growth and 8% sequential contraction, Power & Sensor Systems (or PSS) reported 9% yoy growth and 11% sequential contraction, and Connected Secure Systems (or CSS) reported 24% yoy and 8% qoq growth.
Gross margin improved by 530bp yoy and 290bp qoq to 49.2%, beating by close to five points. Operating income rose 54% yoy and 5% qoq, with margin up 530bp yoy and 250bp qoq to 28%, with sequential margin improvement in every segment except PSS, which was flat. Three of the four segments had margins in excess of 28% (CSS being the exception at 23.5%).
Management guided to flat revenue sequentially, a strong guide relative to most chip companies for the period. While end-market demand remains healthy in many markets, orders are starting to correct (backlog declined 12% qoq), and inventory days jumped from 115 a year ago and 122 in the prior quarter to 142.
Auto And Energy Look Good, Industrial Is A Bigger Concern
I do see some risk to the sell-side outlook for auto builds in 2023, and Infineon's management was likewise cautious about volume growth expectations. On the other hand, EV launch plans continue to go forward apace and new models (ICE or EV) continue to go out with considerable per-unit semiconductor content growth across a range of applications (ADAS, infotainment, instrument panels, etc.). Auto MCUs remain sold out largely across the market through 2023, and Infineon is among those chip companies looking to reallocate surplus capacity for consumer MCUs and MOSFETs toward auto chip production.
Demand from renewable energy generation and grid-level transmission remains strong. Countries continue to add capacity, while grid operators continue to look to upgrade their grids to incorporate more renewable generation and improve overall reliability.
Consumer markets, including phones, PCs, and IoT devices (smart homes, et al.) remain weak. This is nothing new, and it's a widely-reported phenomenon echoed by Microchip ( MCHP ), NXP Semiconductors ( NXPI ), STMicro, Texas Instruments ( TXN ), and so on.
At this point, I'm incrementally more concerned about Infineon's exposure to industrial markets. While I expect automation and electrification (as well as IIoT) to be strong multiyear megatrends, that doesn't mean growth in every single year. Given the guidance from numerous multi-industrials, I believe demand for industrial drives (used in factory automation, machine tools, material handling, and robotics) will get weaker from here, as will some other industrial-related power, sensor, and controller markets.
My bigger concern at this point is that end-market demand really hasn't corrected yet outside of the company's consumer markets. Tight supply has kept auto chip pricing quite strong, and I'm concerned that this will ultimately lead to a situation of "the higher the climb, the steeper the fall" when supply comes online. To be clear, I'm speaking more to the risk of significant price declines, as this has been the prime driver of revenue growth for the sector for about a year.
Powering Up
Infineon's management had been signaling their intention to get more active in M&A again, and they announced a significant deal on March 2, 2023 - paying $830M in cash for GaN Systems . GaN Systems is a leading fabless producer of GaN power semiconductors, and I believe they're #2 in the market (behind Power Integrations ( POWI )).
As I've written in other pieces, I'm bullish on GaN power, as it offers attractive solutions (relative to silicon and silicon carbide) for power management up to around 600V, with very high switching frequencies, good power density, and lower weight. While SiC has gotten a lot of attention (if not hype), and legitimately so, I think GaN power has gone relatively less heralded. I like this deal, and I think we're going to hear more in the coming years about peer companies looking to position themselves in GaN power so that they can offer a more complete range of solutions to customers across silicon, SiC, and GaN.
The downside is that GaN power is a growth market with scarcity value, and Infineon almost certainly had to pay up - given the best available third-party data I can find, I think Infineon may have paid something in the neighborhood of 20x trailing revenue. That's admittedly high, but I think we're in the early days of what will be a significant ramp in GaN power demand for applications like servers, industrial motors/drives, energy storage, appliances, vehicle charging (stationary and onboard), and renewables, and I don't think the price will seem so unreasonable in five years.
The Outlook
As I said, I really like Infineon's leverage to power semiconductors, as I believe electrification will be a major multiyear megatrend. The opportunities in vehicle electrification are pretty widely known, but I think it may be less appreciated that electrification will also be essential in greater adoption of factory and building automation (including "smart buildings") and there will be significant demand for power semiconductors as more renewable generation comes online and as utilities look to improve their grids (not to mention growth in microgrids).
I'm also bullish on Infineon's sensor, MEMS, and IoT capabilities, as I think Infineon offers a good combination of high-quality MCUs, sensors, and connectivity, where companies like Silicon Labs ( SLAB ) tend to be stronger on the connectivity side but lacking elsewhere.
With that bullishness, I do still see near-term risks. I believe lead times could still correct more sharply than currently forecast, and there could be greater price risk here than commonly appreciated. I do also see some risks to increased domestic supply of power devices in China from locals like BYD Semi , StarPower , and Times Electric , as China's government clearly wants to have a strong local source of these critical components. I also see risks to free cash flow as the company continues to invest in its internal manufacturing capabilities. I believe these investments are necessary to support attractive long-term growth, but it's a situation where the costs are near-certain and immediate, while the benefits accrue over time.
I'm expecting long-term revenue growth of over 7%. While that's a lower growth rate than in my prior article, my out-year estimates are actually higher, and the lower growth rate is just a byproduct of a higher starting point (FY'22). Likewise, although I've reduced my near-term FCF margin assumptions on some near-term operating margin compression and higher capex spending, I still expect long-term adjusted FCF margins to reach the high-teens to 20% level, driving double-digit annualized growth.
The Bottom Line
Between discounted cash flow and margin-driven EV/EBITDA and EV/revenue, I believe Infineon is around 15% to 20% undervalued today. I do think there could be more near-term risks than I have in my model, but I'm comfortable with the longer-term outlook given Infineon's strong positioning in areas like power (MOSFETs, IGBTs, et al.), MCUs, connectivity, and sensors. I certainly can't promise that these shares will be higher in six months or even 12 months, but I do think the returns over the next three-plus years will be attractive, and I think more patient, long-term-oriented investors should take a closer look today.
For further details see:
Infineon Looks Like A Classic 'Short Term Vs. Long Term' Story