Summary
- MediaTek's results are softening.
- The semiconductor industry is in the early innings of a downcycle and the coming quarters are likely to remain challenging.
- With strong fundamentals, the company is able to weather the downturn and is poised to benefit from long-term growth drivers from the 5G upgrade cycle.
- MediaTek, however, faces considerable geopolitical risks.
After a pandemic-induced semiconductor boom over the past few years, the industry is beginning to see early signs of a downturn and MediaTek's ( OTCPK:MDTKF ) results are seeing signs of deceleration. The slowdown is likely to continue over the coming quarters however the company is well poised to benefit from long term structural growth drivers. Although the company is quite cheap (the stock trades at a single digit p/e), with a cloud of geopolitical uncertainty hanging over Taiwan, MediaTek may not be particularly appealing for the time being.
Softening results
MediaTek, the world's largest 5G smartphone chip supplier, reported decent results for Q3 2022 amid challenging industry conditions. Revenues for the quarter rose 8.5% YoY to TWD 142.2 billion (as customers turned cautious about placing mobile chip orders amid sluggish demand and rising inventory) , marking the first single digit quarterly YoY revenue growth rate since Q4 2019 .
Operating profits were up 12.9% YoY to TWD 33.1 billion and despite an inflationary environment, MediaTek's margins held up with gross margin unchanged at 49.3% for the quarter, operating margin up one percentage point to 23.3%, and net margin up marginally by 0.3 percentage points to 22.6%.
Growth was led by Smart Edge Platforms, MediaTek's second-largest business which grew 11% YoY during the quarter, followed by MediaTek's largest business - Mobile Phones - which saw revenues rise 7% YoY. Power ICs, MediaTek's smallest division grew 4% YoY.
Soft near term prospects
High inflation, deteriorating economic prospects, and a strong US dollar are discouraging customers from buying smartphones and computers, particularly in emerging markets such as Southeast Asia and Africa, as well as weakness in China, the world's biggest smartphone market where smartphone shipments dropped 23% YoY for the eight months to August. Smartphone shipments worldwide have been sliding this year (down 9% YoY in Q2 2022, and 11% in Q1 2022 according to Canalys), hitting smartphone makers, particularly Chinese phone makers dominating the mid-to-low segment see market share losses while smartphone leader Samsung, and premium smartphone leader Apple ( AAPL ) both saw market share gains in Q2 2022.
Canalys
The trend hit MediaTek particularly hard, as unlike rivals Qualcomm ( QCOM ) and Samsung ( OTCPK:SSNLF ), the company has a relatively higher dependence on the mid-and low end smartphone segments.
The drop in smartphone demand is leading to an inventory buildup and consequently MediaTek's customers are turning cautious about placing orders. Meanwhile cost pressures are rising as an inflationary environment is prompting foundry partners to raise prices.
Semiconductor cycles typically last a few years and with the current downturn only beginning in 2022, industry weakness is likely to continue for several more quarters; inflation continues to rage on eroding consumer purchasing power, financial conditions continue to tighten , the Russia-Ukraine conflict shows little sign of abating, and covid lockdowns continue in China. Gartner foresees smartphone semiconductor revenues dropping 3.1% and PC semiconductor revenues dropping 5.4% in 2022. With emerging markets particularly vulnerable to such macroeconomic headwinds, the trend could potentially have a significant impact on MediaTek's Mobile phone business which accounts 55% of revenues, and on MediaTek's Smart Edge Platform business which accounts for about 38% of revenues.
By 2023 however, Gartner expects the current semiconductor downturn to recede and long term prospects look bright.
Poised to benefit from continued efforts to move up the premium and flagship segment, and 5G upgrade cycle
MediaTek's high-end Dimensity 8000 and 9000 SoCs which "have powered numerous popular models" are the fruit of MediaTek's efforts to penetrate the high end and flagship segments. The company continues to make headway in this segment and their next generation flagship SoC is expected to be released in November . Chinese smartphone makers including Xiaomi ( OTCPK:XIACF ), OPPO, and Vivo are increasingly vying for the premium handset market and MediaTek who already counts them as customers is positioned to benefit.
The 5G upgrade cycle is underway, and has ample room for growth, particularly in emerging markets where Chinese smartphone makers have a stronghold ( 5G penetration is highest in developed countries in China and the West ). MediaTek management expects 5G penetration to increase to mid- 50% in 2023, up from high-40% in 2022, which means there is more opportunity left in the coming years for further 5G penetration.
MediaTek has an extensive portfolio of 5G products, including sub-6 gigahertz and millimeter wave (a 5G technology which is particularly popular in the U.S. but not so in China), but China recently began pushing for the technology, opening a tremendous opportunity for MediaTek who is arguably the best positioned to capitalize on this opportunity thanks to its close relationships with Chinese smartphone vendors. mmWave phones are typically more expensive than non-mmWave phones, and could thus support MediaTek's continued revenue growth. MediaTek is also beginning to supply mmWave chipsets in the U.S. with the company's Dimensity 1050 mmWave Soc having already begun volume production in the country where about three in four of the nearly 150 million smartphones sold in the country support the technology. For MediaTek, not only does the effort expand their addressable market, but it also helps gain a toehold into the higher end segment.
Moreover, the 5G opportunity is opening a 'Digitalization of Everything' world, a structural growth driver set to propel demand for semiconductors for a plethora of devices beyond smartphones and computers, a boon for MediaTek which supplies a broad array of IoT-related components including modems, smart TV SoCs, and automotive chips. Apart from an opportunity to expand its top line, the opportunity could also help MediaTek reduce its reliance on smartphone chips.
Financially solid
Financially the company is solid and in good position to weather the downturn. With a debt to equity of 11.93 and an interest coverage of 561, MediaTek has a lower leverage and higher interest servicing capability than rival Qualcomm enabling it to withstand an increase in interest rates and any drop in profits. Inventory levels however have been on the rise (inventory turnover increased to 111 days in Q3 2022, higher than 104 days in the previous quarter, 86 days in the same quarter last year, and considerably higher than the company's normal range of 80 to 90 days). Although the increase is concerning, MediaTek expects its inventory days to return to normal by the first half of next year.
MediaTek | ||
Total debt to equity | 11.93 | 96.87 |
Interest coverage | ||
Current ratio |
Risks
MediaTek, a Taiwanese company, faces significant geopolitical risks. Tensions between China and the U.S. are rising, and any U.S. imposed sanctions on China could hurt MediaTek who counts all Chinese smartphone makers as customers. MediaTek's share price tumbled following Washington's sanctions on Huawei in 2020, and any similar actions against other Chinese smartphone makers could be detrimental to MediaTek.
In October 2022, Washington imposed a broad sanctions package aimed at halting Chinese companies' access to high performance chips, a move similar but broader in scope to that imposed on Huawei a few years ago. The companies are currently limited to Chinese semiconductor companies , but if expanded to smartphone and other computing device makers, MediaTek (who depends on TSMC to fabricate most of its chips, who in turn depends on U.S. technology) could suffer material financial consequences.
Summary
The semiconductor industry is headed for what is expected to be the worst downturn in decades . Semiconductor downturns typically last for several quarters and the downturn is expected to last for about a year or so which suggests soft near term prospects for MediaTek.
With solid fundamentals, the company is strong enough to weather the downturn, and well positioned to benefit from the industry's bright long term prospects. With a P/E of about 7.6 (Qualcomm P/E is around 10 ), MediaTek is quite cheap but with the industry likely to continue exhibiting softness over the coming quarters along with considerable geopolitical uncertainty, investors may wish to wait for a better entry point.
Analysts are split between buy and hold.
WSj
For further details see:
MediaTek: Near-Term Weakness Amid Industry Downturn, Better Prospects Long Term