2023-11-17 12:00:18 ET
Summary
- Despite facing headwinds in a challenging semiconductor market and a broader economic slowdown, Infineon has demonstrated resilience and an impressive performance in FY23.
- The company's strategic positioning in fast-growing sectors like automotive, cybersecurity, and sustainability has contributed to its success.
- Infineon reaffirmed its long-term goals and expects to deliver over 10% annual revenue growth through the cycles, resulting in superior shareholder value generation.
- Margins sit at multi-year highs and the company is in excellent financial health, allowing it to make strategic acquisitions and reward shareholders.
- Shares are trading at a discount to peers and historical averages. Based on conservative estimates, shares should be able to return over 21% annually based on a current share price of €34.
Introduction
Infineon ( IFNNY ) shares jumped 9% in yesterday’s trading session following the company’s Q4 and FY23 earnings report. Despite facing headwinds in a challenging semiconductor market and a broader economic slowdown, Infineon has demonstrated resilience and an impressive performance in FY23. The company's ability to outpace the global semiconductor industry by maintaining a 15% YoY revenue growth in the face of a 13% contraction in the industry is commendable. This success is attributed to its strategic positioning in fast-growing sectors like automotive, cybersecurity, and sustainability.
While certain segments, such as Power & Sensor Systems, faced challenges in FY23, the overall strong performance across key segments like automotive and Green Industrial Power has driven notable margin expansion. The company's prudent financial management is evident in its robust balance sheet, increased cash reserves, and the ability to make strategic acquisitions, such as the recent GaN Systems purchase.
Crucially, Infineon reaffirmed its long-term goals during the earnings call, even in the face of prolonged economic weakness and a weakening demand environment in response. Through the cycles, Infineon believes it will deliver over 10% annual revenue growth, an average segment result margin of 25% (not to fall below a high-teens range in downcycles), and an adjusted free cash flow margin of 10% to 15% of revenue.
This bullish long-term outlook and expected outperformance compared to the industry is driven by the company’s extremely favorable positioning toward secular growth drivers like digitalization and decarbonization. This translates into more profitable growth and, hence, superior shareholder value generation.
Do I need to say more? This company is trading at 13.5x this fiscal year’s earnings, an incredibly discounted multiple in a year where earnings are taking a hit from a challenging operating environment. Furthermore, important to note here is that Infineon expects to report these revenue growth and margin levels through the cycles and not just in the good years. I think we can all agree that a technology company growing revenue by double digits through the cycles should not be trading at a 13.5x earnings multiple, right?
This makes the investment thesis here quite simple: Infineon is a leading analog semiconductor manufacturer with a de-risked revenue stream, strong in-house manufacturing mainly located in Europe, a strong market share in its key end-markets, and exposure to high-growth secular trends that drive above-industry growth through the cycles. Meanwhile, it trades at a significant discount to peers and historic averages. This company is a bargain today and presents an opportunity to investors with a long-term investment horizon and a stomach for some volatility. Shares have underdelivered over the last year but are poised to outperform over the next 5+ years.
Therefore, today, I reaffirm my “Strong Buy” rating on Infineon Technologies AG. Even as I am forced to lower my near-term outlook, shares continue to trade at a significant discount, while revenues and earnings should rebound quickly once the demand environment improves.
On that note, let’s take a deeper look at the Q4 earnings in order to get a sense of the operational developments and the company’s performance and near-term outlook. For those unfamiliar with this company, I recommend reading my January deep dive first, which can be found here .
Infineon reports resilient top-line growth
Infineon reported its Q4 and FY23 earnings earlier this week on November 15 and managed to deliver quarterly results in line with guidance, reflecting a weakening demand environment as had already been confirmed by peer results in recent months. Infineon saw growth slow down meaningfully in Q4 to just 1.5% after starting the fiscal year by reporting 25% growth in Q1. This resulted in Q4 revenue of €4.15 billion, topping my estimates by €60 million and representing growth roughly in line with what we have already seen from peers in recent weeks.
The semiconductor industry continues to face a weak demand environment, and Infineon and its peers are no exception. Inflation remains high, interest rates are at the highest point in a very long time, and a recession in 2024 is still not out of the question. This cloudy outlook and the depressed consumer spending levels, as a result, lead to lower demand for Infineon products as its customers scale back on investments and are forced to bring down inventory levels.
Nevertheless, Infineon’s FY23 performance is just impressive. For perspective, the global semiconductor industry contracted by 13% over the last 12 months, and according to Infineon’s calculations, its own reference market contracted by approximately 1%. Meanwhile, Infineon reported revenue growth of 15% YoY to €16.3 billion, outperforming the underlying industry by a distance. This is not only a very impressive outperformance but also means Infineon has continued to win share over the last 12 months in all its key markets, solidifying its long-term revenue potential.
This outperformance against the global semiconductor industry benchmark is primarily the result of the company’s favorable positioning toward faster-growing industries and global trends like automotive, cybersecurity, and sustainability. As investment cycles in these particular industries are more resilient compared to mature and cyclical industries like consumer electronics, this supports Infineon’s sales resilience.
Further contributing to this is the company’s excellent revenue diversification, with no single region accounting for over 25% of sales and no single end customer accounting for over 10% of its FY23 sales. This makes the company less sensitive to company or region-specific issues, lowering the risk profile and supporting a less sensitive revenue stream.
The combination of all these factors has allowed Infineon to outperform in FY23 and, going by management’s FY24 guidance, should protect it from reporting negative numbers for FY24 as well. From this perspective, short-term or long-term, the company remains one of the best-positioned among peers, especially when considering the company also still has an order backlog of €29 billion.
Now, before diving deeper into the results by looking at the performance for each of its end markets, it is worth highlighting that another factor supporting the strong FY23 performance and FY24 outlook is the company’s focus on growing its silicon carbide offering. This has been a bright spot in FY23 as management sees unabated momentum from industrial as well as automotive customers. This led to SiC revenue growth of 65% to around €500 million in its fiscal FY23. Going by Mordor Intelligence’s estimated market size of $1.74 billion, this means Infineon currently holds a market share of around 30% in this incredibly lucrative market, projected to grow at a CAGR of over 25% through 2028.
Meanwhile, Infineon is rapidly increasing its SiC production capacity by building the world's largest, most competitive 200-millimeter silicon carbide power fab in Kulim, Malaysia. Driven by this expansion and the rapid growth in this market, Infineon expects another year of growth of over 50% in FY24 and reaffirmed its goal to reach over €1 billion in SiC revenue by 2025 and €7 billion by 2030.
Automotive and Green Energy are still the largest growth drivers, offsetting weakness elsewhere
Let’s take a look at the quarterly results by end-market, starting with automotive. Automotive revenue in Q4 was €2.16 billion, up 2% sequentially and 12% YoY. This was driven by broad-based healthy demand and market share gains in microcontrollers.
As a result of this healthy demand combined with positive mix effects and stable pricing, Infineon expanded the segment’s segment result margin by 110 basis points sequentially and 230 YoY to 28.5%. This resulted in a segment result of €617 million, up 22% YoY.
Infineon continues to hold the #1 market share position in automotive semiconductors with 12.4% through its leading share in automotive power semiconductors (31.9%) and strong presence in sensors and MCUs, both sitting above 20% as well. Over the last three years, the company has realized a staggering €40 billion in design wins.
This substantial market share and the continued share gains allow Infineon to fully benefit from the strong growth in the industry, driven by the growing number of semiconductors required in cars due to the increasing importance of advanced technologies, mainly driven by growth in BEVs for which the electrical systems massively increase semiconductor demand.
According to Infineon, in 2023, the average ICE car requires $750 in semiconductors to power all its systems, and this number almost doubles for each BEV at $1300. Furthermore, as on-board technologies keep growing, this number should expand to up to $2000 by 2030, presenting a lucrative growth opportunity for Infineon as the undisputed industry leader.
The Green and Industrial Power segment was another bright spot in Q4, with this segment also remaining resilient, growing revenue by 7% YoY to €582 million. This was mainly driven by decarbonization investments. To put Infineon’s importance in decarbonization into perspective and to highlight how it benefits from these investments, this is what I wrote in a prior article :
As explained in my previous article, Infineon is responsible for powering 50% of the currently installed capacity in wind and solar energy. In addition to this, Infineon's power semiconductors are also used for 2/3 of the electricity grid infrastructure, including electric charging. Clearly, Infineon has great exposure to the decarbonization trend and is well-positioned to benefit from growth in green energy generation and electricity grid infrastructure growth going forward.
As a result of resilient demand in this segment, profitability also remained at a high level. The segment result margin was 28.5%, up 340 basis points YoY as the company has impressive pricing power. This resulted in a segment result of €166 million, up 22%.
However, not all of Infineon's segments performed this well, as Power & Sensor Systems ((PSS)) saw revenue contract by 22% YoY, reflecting the downswing in consumer computing and communications. Luckily, this segment accounted for only 22% of revenue whereas automotive and Green Industrial Power together account for 66% of revenue. This somewhat helped the group’s performance.
Nevertheless, the segment result fell to €172 million, down 49% YoY. This reflected a margin of 18.9%, down a staggering ten percentage points as the top-line contraction weighed heavily on this result.
Finally, Connected Secure Systems saw revenue increase 3% sequentially to €419 million, flat YoY, driven by robust demand for security solutions, which offset weakness in IoT applications. However, even as the segment result margin fell to 18.4%, down 640 basis points sequentially, this was still up 90 YoY. This meant the segment result was still up 5% YoY to €90 million.
Infineon reports new highs in terms of margins but these are not here to stay
The strong top-line outperformance for FY23 went hand-in-hand with a notable margin expansion as the segment result margin came in at 27%, 320 basis points up from the previous year. Furthermore, the gross margin also expanded by 200 basis points to 47.3%, reflecting primarily the impact of higher volumes, better pricing, and an increased share of value-added system solutions.
This also led to an operating margin expansion of 420 basis points to 24.2% and a net income margin of 19.2%, up 390 basis points. Infineon has consistently increased its margins across the board over recent years, with these now sitting at multi-year highs. Yet, with the operating environment deteriorating, these will probably contract slightly over the next 12-18 months as the incredible pricing strength from the last years will slowly disappear. Therefore, these margins aren’t sustainable and will probably not reach similar levels for at least three years. A segment result margin of closer to 25-26%, in line with management’s goals, is more likely in the near term. Yet, this should still result in decent EPS growth, driven by resilient margins and top-line growth. On the note of EPS, this was $0.65 in Q4, topping my estimates by $0.04 and up 3% YoY.
Moving further down the line, adjusted FCF was €1.6 billion in FY23, reflecting a margin of 10%. This easily covers any obligations and supports the strengthening of the balance sheet. At the end of its fiscal Q4, Infineon held €3.6 billion in cash on the balance sheet, up from €3 billion three months earlier, against €4.7 billion in debt. This reflects a gross leverage of 0.8x or a net leverage of 0.2x.
Therefore, it is safe to say that Infineon is in great financial health, and this has allowed it to acquire GaN Systems in late October for $830 million in cash (I discussed the acquisition in depth in my prior article). In addition, the company plans to increase the dividend to €0.35, leading to a payout of €460 million annually, easily covered by FCF, even after significant capital investments.
This planned dividend increase would bring the yield to just over 1%, based on a current share price of €34. While this yield is not overly attractive or a reason to buy the shares, the growth potential is much more attractive, and the dividend should be safe, even as we enter a prolonged period of weak economic growth.
Outlook & Valuation – Is Infineon a Buy, Sell, or Hold?
Starting with the end-market outlook, Infineon management remains quite bullish on the prospects it has in automotive, projecting low double-digit sales growth for FY24, even amid limited growth in vehicle volumes. Infineon expects continued growth in EV adoption and semiconductor content growth to offset this vehicle volume weakness. Meanwhile, margins will most likely drop slightly for this segment, with an expected segment result margin between 25% and 28% as some of the pricing power disappears due to lower demand. Still, the segment will remain a growth driver.
Moving to the Green Industrial Power segment, management also expects to see demand resilience here to persist, driven by decarbonization investments. Some weaknesses in core industrial applications like factory automation or robotics result in a somewhat mixed outlook with growth in the mid-single-digits potentially.
Meanwhile, the outlook for the PSS and CSS segment remains uncertain and challenging. Management does not expect a broad-based demand inflection to appear before the second half of the year, and I share this vision as we still see high inventories, and the consumer continues to weaken, with a recession still a possibility.
However, in management’s words, “the cyclical development does not diminish the highly attractive structural growth opportunities.” Growth dynamics in the longer term remain favorable, and management remains committed to its long-term growth goals.
Overall, management expects to see a bottom in 1H24 and a cyclical recovery to start sometime in the second half of the fiscal year. This results in FY24 revenue guidance of around €17 billion, plus or minus €500 million. This reflects a positive YoY growth of 4%.
This comes with a gross margin guidance of around 45%, down from over 47% in FY23, as the company keeps up investments and expects to see pricing power moderate. Nevertheless, FCF is expected to hold up well at around €2.2 billion (excluding investments into major front-end buildings and the GaN Systems acquisition), representing around 13% of sales.
Finally, for Q1, management guides for revenue of around €3.8 billion and a segment result margin of 22%.
Following this guidance, the Q4 results, and the underlying and operational developments, I have slightly revised my near-term outlook. I have lowered my expectations for the company’s fiscal FY24 as it is increasingly facing a challenging demand environment. However, I expect a gradual recovery from the second half of the fiscal year onward. My long-term expectations remain unchanged as I am still very much bullish on the company’s long-term prospects.
Based on these estimates, shares are now valued at 13.5x this fiscal year’s earnings, meaning these trade at a discount to peers like ON ( ON ) and NXP ( NXPI ). I believe Infineon is much better positioned with a stronger growth outlook. Furthermore, this also means shares continue to trade at a discount to the 5-year average of 16.5x forward earnings despite management upgrading the long-term outlook last year.
Overall, considering Infineon’s growth outlook, sales resilience, and low risk profile, it is safe to say that shares continue to trade at a significant discount. The company is projected to outgrow most of its peers and, in the meantime, is showing a more resilient performance amid economic headwinds, with revenue growth expected to remain positive, whereas many semiconductor peers have been reporting negative growth for FY23 already.
Everything considered, I believe an 18x multiple, closer to Analog Devices ( ADI ) and Texas Instruments ( TXN ), is justified for Infineon. Based on this belief and my FY25 EPS projection, I calculate a target price of €50, down from a previous €55. However, even after lowering my price target, shares continue to trade at a discount. They should be able to return over 21% annually from a current share price of €34, making this an extremely attractive opportunity.
Shares have been under pressure for much of the current year and unjustly so. The company continues to outperform peers and the underlying industry, driven by its extremely favorable positioning and continued market share gains through innovation and design wins.
My bullish view on Infineon remains unchanged following its Q4 and FY23 results, and even in the face of a challenging year ahead, I maintain my “Strong Buy” rating as I see significant upside for the shares.
For further details see:
Infineon: Still Trading At A Significant Discount - 47% Upside