Disappointing earnings

Last Thursday semiconductor giant Intel reported that its fourth quarter revenues reached a mere US$14 billion. This was a third down from a year ago and one of the worst quarter’s performance in its history. The company’s full-year 2022 revenues of $63.1 billion was also 20 percent lower than a year ago.

Investors were disappointed and Intel shares sold down by close to 10 percent. The shares of other US chip companies, including Nvidia and AMD also fell, although less steeply.

Post-Covid blues

Intel and others in the semiconductor industry are suffering the effects of Covid-related adjustments. PC sales during the Covid lockdown were sky high, prompting PC manufacturers to hurriedly boost their chip inventories. So when the lockdowns ended, manufacturers simply tapped their bloated inventories, especially amid weakening sales.

2022 saw sales fall further. Faced with high inflation, a possible recession and recent PC upgrades, consumers have stayed away. As a result, the fourth quarter of 2022 saw the weakest quarterly PC sales since the mid-1990s.

Figure 1: PC vendor unit shipment declines 4Q21 – 4Q22 (%)

Source: Gartner, January 2023

Fears of a global recession have also caused businesses to delay their data centre expansion plans.  This post-Covid plummet in both consumer and business demand is undermining chip-makers’ profit margins. Intel’s profit margin reached a high of 59 percent in 2Q21, but this is expected to fall to 39 percent in 1Q23, according to company forecasts.

Gradual turnaround

However, these trends do not point to a long term structural decline and indeed, the green shoots of a recovery are starting to emerge. For example, the restocking of certain types of chips, such as Large-sized Display Driver ICs (LDDICs) used in TVs, notebook computers and desktop monitors, appears to be underway.

More advanced chips, such as ASICs (Application-Specific Integrated Circuits) are also seeing a faster recovery in demand, especially from recession-proof, deep tech industries such as defence, avionics and communication satellites.

All eyes are now on China. More cautious spending in the midst of the country’s zero-Covid policies had resulted in, for example, 286 million smartphones sold in 2022, the lowest in a decade. But alongside China’s reopening is also the likelihood of a consumption rebound, new model launches and meaningful restocking.

All this suggests that global chipmakers could see their revenues bottom out in 2Q23 and then pick up thereafter. With the end of the decline now in sight and valuations looking more attractive, we would expect this sector to see near-term investor interest.

US and China chip rivalries

This turnaround is particularly pertinent for China, given the country’s shift towards more manufacturing based technologies such as semiconductors. However, as highlighted previously, the US and China are locked in a chip war. Last year, the Biden administration announced controls on the export of advanced chip technologies to China and urged its allies and trade partners to do the same. This month, Japan and the Netherlands are thought to have signalled their intention to follow in the US‘s footsteps.

In response, China is working to establish a self-sufficient chip industry, and it was reported recently that a US$144 billion funding package has been created to support the country’s fledgling chipmakers.

China is playing the long game

While newer technologies are out of reach, these chipmakers are focused on accelerating the production of 28nm chips, which relies on a decade-old technology. For example, China’s largest chip manufacturer, SMIC, starting building four new facilities in 2020 and when completed, will have the capacity to triple their current production.

Given that 28nm chips still occupy over half of the global semiconductor market, the pending recovery will help boost the fortunes of the Chinese chip sector and buy it some time. A ready supply of locally-made chips will help to mitigate shortages as was experienced by China’s car and consumer electronic manufacturers in 2021. In the meantime, the same chipmakers will be racing to close the tech R&D gap with its global competitors.