2023-05-30 13:18:07 ET
Summary
- STM's shares have underperformed due to concerns about weakening demand and pricing, but analysis suggests a sharp industry downturn is already priced in.
- STM remains a top pick within European tech hardware coverage, with a target price of €65 and an Outperform rating maintained.
- Key risks to the target price and rating include cyclical demand weakening, supply disruptions, loss of sockets at key customers, and adverse €/$ moves.
Today, we are back to comment on STMicroelectronics ( STM ). Here at the Lab, we believe that Wall Street is pricing in a significant downturn, and since we believe this is already priced in, we decided to maintain our outperforming rating . Year to date, STM's stock price is up by 20.66%, while the PHLX Semiconductor Sector Index appreciated by a remarkable +40.03% (Fig 1). STM's underperformance is due to uncertainty about volume and pricing power; however, after having scrutinized these ongoing concerns and reverse engineering STM stock price action, we might conclude that STM's volume should decline by approximately 15/16% over the next two years. This is not evident in the last quarterly presentation and assumes a worse slowdown happened during the financial crisis (semi volumes were at minus 13%). Aside from the revenue decline, we also backed test STM's price with a margin decline, and STM's operating profit margin should decrease by 800 basis points by 2024 in our view.
Source: Mare Evidence Lab's analysis
From Q1 to Q2 Results
During Q1, STMicroelectronics reported higher-than-expected data and also a positive outlook for the second quarter. The chipmaker ended with top-line sales at $4.24 billion (beating its internal guidance and Wall Street estimates at $4.20 billion and $4.21 billion respectively). Turnover was up by 19.8% on a yearly basis. Going down to the P&L, the operating margin was very supportive and improved to 28.3% from 24.7% with favorable gross margin evolution. This was due to pricing power, improved product mix, and positive currency effects. In detail, the CEO explained that Q1 gross margin reached 49.7% and was 170 basis points above the midpoint. For this reason, net income jumped by 39.8% to $1.04 billion, and diluted EPS reached $1.10, beating the median analyst estimate of $0.99. In addition, at March-end, the company's net financial position was positive by $1.86 billion. What is important to report is that for the second quarter, the CEO seems optimistic, after he explained how : " net revenues are estimated at $4.28 billion as an intermediate value, corresponding to a year-on-year growth of 11.5% and a 0.8% increase over the previous quarter; the gross margin is expected to be around 49% ". This forecast is based on a euro/dollar exchange rate of approximately 1.08 and includes the impact of existing hedging contracts. Current consensus estimates see $4.24 billion in revenues with a gross margin of 47.1% and an EBIT of 1.11 billion.
Source: STM Q1 results presentation
To support our long-standing buy, STM has also improved its 2023 guidance, raising the lower-end revenue outlook. The company is guiding yearly top-line sales in the $17 billion and 17.8 billion range. Previously, the company had reported year-to-date revenues of between $16.8 billion and $17.8 billion. The company's CEO also confirmed 2027 financial targets: $20 billion and 50% in revenue and gross margin respectively.
On a negative note, STM's CAPEX increased to $1.09 billion from $0.84 billion recorded in Q1 2022. Cash and equivalents also decreased and inventories grew to $2.87 billion (122 days) compared to $2.58 billion at 2022 end. Inventories days were 104 in Q1 2022. Revenue growth was mainly driven by the automotive and industrial sectors, while the smartphone segment remained weak.
Our upside and Valuation
Over the month, there was the EU plan green light to increase microchips industrial production. We already reported the European Chips Act as a clear upside. However, this law took a year to reach an agreement with the EU Commission. The plan provides for total investments of €43 billion , divided between public funding (above all) and private investments, as well as the establishment of a specifically dedicated fund for state aid. Furthermore, great importance was given to R&D. The plan aims to reach 2030 with a European share of 20% of world microchip production, more than doubling the current percentage of EU microchip production which is around 9% . In fact, Europe depends almost entirely on chip supply from abroad and for this reason, it has found itself in difficulty with the problems of shortages in global chains and with tensions between China and Taiwan. In addition, as already mentioned above, the company confirmed a positive trajectory for Q2 and increased the low revenue guidance for 2023.
Going to the valuation, we are valuing STM using a Price Earnings multiple of 16x on our 2023 earnings per share estimate at $4.28. Even applying a discount on the P/E basis, given higher rates, and adding also net cash per share of $1.9 billion, this leads to our base case scenario with a fair value and buy target of €60 per share . The company remains a top pick within our EU tech coverage and we maintain our outperform rating. Our risks include logistic disruptions, lower demand, adverse €/$ moves, gross margin and opex trends, and inventory evolution.
For further details see:
STMicroelectronics: Positive EU Framework