2023-09-27 07:34:03 ET
Summary
- STMicroelectronics is a leading semiconductor company in Europe, specializing in automotive chips, analog products, and microcontrollers.
- The growth of silicon carbide technology and semiconductor content per vehicle is driving the automotive semiconductor industry.
- STMicroelectronics stock is undervalued and stands as one of the top semiconductor stocks in Europe, with a strong focus on silicon carbide technology.
STMicroelectronics ( STM ) is one of the leading semiconductor companies in Europe, manufacturing automotive chips, analog products, and microcontrollers. They are at the forefront of silicon carbide technology, alongside three other major players, including Infineon ( OTCQX:IFNNY ), ON Semiconductor ( ON ), and ROHM Semiconductor. The growth of silicon carbide and semiconductor content per vehicle is a significant driver for the automotive semiconductor industry. I assign a "Strong Buy" rating to STMicroelectronics, as I believe its stock is undervalued, and it stands as one of the top semiconductor stocks in Europe.
Silicon Content Growth in Automotive End-Markets
Automotive and Discrete Group ((ADG)) represents 37% of group revenue, and it grew 32.5% in FY21 and another 37.2% in FY22. Along with the structural growth over the past few years, their segment margin has been improved from an approximate 10% in FY19 to 24.6% in FY22. Their growth has been driven by automotive electrification, ADAS system and 32-bit MCUs. STMicroelectronics management expects the semiconductor content per car further acceleration in the next few years driven by more technologies applied on premium car and EVs.
I believe the growth of semiconductor content per car is crucial to the automotive semiconductor industry, and it could be a major growth driver for the entire chip industry. Historically, automotive OEMs paid less attention to semiconductors, often neglecting to build their chip inventory and treating semiconductor companies as non-critical partners, based on my research. However, the global supply chain disruptions during the pandemic served as a meaningful lesson for these automotive OEMs—a wake-up call. Since then, these automotive OEMs have begun to realize that semiconductors are mission-critical components in the design and manufacturing of new cars. With technological advancements leading to increased electrification and safety features, the demand for chips in vehicles continues to rise. I have no doubt that the average semiconductor content per car will continue to grow over the next decade.
Leading Silicon Carbide Technology
Along with Infineon, On Semiconductor, and ROHM, STMicroelectronics has the leading technology for silicon carbide, a new material better suited for longer-range electric vehicles. Silicon carbide's advantages lie in its high system-level efficiencies, low power loss, and increased temperature operations. With silicon carbide material, EVs can achieve longer ranges on shorter charge times and with smaller battery sizes for traction inverters.
STMicroelectronics is targeting more than EUR 5 billion in revenue from silicon carbide by FY30, and their customers include major automakers, such as BMW ( OTCPK:BMWYY ), Tesla ( TSLA ), BYD ( OTCPK:BYDDF ), Renault ( OTCPK:RNSDF ), Hyundai ( OTCPK:HYMTF ), etc.
During Q2 FY23 , STMicroelectronics announced a joint venture with Sanan Optoelectronics for a high-volume 200mm silicon carbide device manufacturing facility in China. This joint venture will manufacture 200mm silicon carbide devices for Chinese customers in automotive electrification, industrial power, and energy applications. STMicroelectronics is targeting to start production in Q4 FY25 and achieve full operation by FY28. Their management indicates that the Chinese JV, and their continuing investment in Italy and Singapore, would become the major growth opportunities for achieving their EUR 5 billion revenue target by FY30. I am impressed with their consistent investment in silicon carbide technologies, which I believe is crucial for the global adoption of electric vehicles.
Financial and Growth Outlook
STMicroelectronics has an ambition to reach EUR 20 billion in revenue, with over 30% of operating margin and 25% of free cash flow margin. I believe these financial targets are realistic and align closely with the long-term ambitions of most semiconductor companies.
Given that they are in the semiconductor industry, revenue growth is quite volatile in nature. It is better to look at the 3-year or 5-year revenue compound annual growth rate to understand the long-term growth trend. For STMicroelectronics, their past 3-year revenue CAGR is approximately 19%, and the past 5-year CAGR is around 14%. I would argue that their growth is quite impressive, as discussed above, driven by the growing demand for automotive semiconductors.
In Q2 FY23 , their revenue increased by 12.7% year over year, with an operating margin improvement to 26.5% from 26.2% in the same quarter of the previous year. Additionally, EPS grew by 15.2% year over year. The Automotive and Discrete Group revenue increased by 34.4% year over year, with double-digit growth in both Automotive and Power Discrete.
For their full-year guidance:
Revenues are expected to be EUR 17.4 billion, plus or minus EUR 150 million, which represents growth of approximately 8% over FY22.
Gross margin is expected to exceed 48%.
Capital expenditure is estimated at EUR 4 billion.
Just based on their first-half year actual earnings, it seems their revenue guidance is quite conservative, especially considering their revenue growth of 19.8% in Q1 and 12.7% in Q2.
It's also worth noting that STMicroelectronics maintains a robust balance sheet, with EUR 1.91 billion in net cash as of Q2 FY23. Their credit rating is well within the investment grade, with a Positive outlook from S&P and Moody's. They generated EUR 209 million in free cash flow in Q2, and their net cash from operating activities increased by 24.1% year over year.
Key Risks
My biggest concerns for STMicroelectronics relate to their high capital expenditures. They allocated 21.9% of total revenue to Capex in FY22, 14.3% in FY21, 12.6% in FY20, and 12.4% in FY19. The increasing capital expenditure has impacted their free cash flow generation. Unlike most U.S. semiconductor companies, STMicroelectronics invests heavily in semiconductor manufacturing facilities.
For instance, in June 2023, GlobalFoundries ( GFS ) and STMicroelectronics announced the conclusion of an agreement to create a new, jointly-operated, high-volume 300mm semiconductor manufacturing facility in France. According to their management, the total investment for this project is expected to be EUR 7.5 billion, and it will benefit from financial support from the French State, amounting to approximately 2.9 billion euros. I acknowledge that these capital investments in manufacturing can help STMicroelectronics better control their supply chain and input costs. However, it's important to note that these capital expenditures make their business capital-intensive in nature.
Valuation
In the DCF model, I assume an 8% revenue growth for FY23, which is in line with their guidance. For the long-term growth rate, I'd prefer to assume a conservative revenue growth rate, as the semiconductor industry is highly volatile in nature. According to Precedence Research , the global automotive semiconductor industry is expected to grow at a compound annual growth rate ((CAGR)) of 11.5% from 2022 to 2030. Considering that STMicroelectronics also includes some lower-growth business lines, I assume an 8% annual growth rate for the company going forward. Regarding profit margins, I don’t expect significant margin expansion over the next decade, as they have already earned very decent margins, and they have to continue investments in new chips and silicon carbide.
In summary, based on a 10% discount rate, 4% terminal growth rate, and a 15% tax rate, the DCF model estimates an enterprise value of EUR 60 billion, suggesting that the fair value of STMicroelectronics' stock is approximately EUR 70 per share, according to my calculations. This indicates that the stock may be undervalued at its current price.
Final Comments
I think STMicroelectronics's growth will be driven by silicon content per car growth as well as silicon carbide adoptions, and they will benefit from the structural trend of automotive electrification. In my opinion, the stock price is significantly undervalued here, and I assign a 'Strong Buy' rating.
For further details see:
STMicroelectronics: Leading Silicon Carbide Semiconductor Player In Europe