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Jeff Reeves’s Strength in Numbers: Five things investors learned about the semiconductor sector from the latest batch of earnings

A leading narrative for investors in 2021 is chronic supply-chain problems weighing on many sectors of the economy, particularly the impact of chip shortages and disruptions in the semiconductor sector.

On one hand, widespread disruptions at chipmakers have trickled down to other industries. A recent report in the Washington Post, for instance, calculated the auto industry stands to miss out on about $210 billion in sales with nearly 8 million fewer vehicles sold as a result of these high-tech supply-chain issues. On the other hand, technology consultancy IDC just warned that some chipmakers may risk overcorrecting as they ramp up supply, leading to a global glut in chips by 2023.

But who knows for sure?

Read: These are the two main reasons you should consider adding semiconductor stocks to your portfolio now

If the pandemic has taught us anything, it’s that even the most thoughtful predictions can be woefully off target. As the semiconductor industry fights through factory shutdowns across Asia in the wake of COVID-19, it’s worth taking a look at the recent batch of third-quarter earnings from major manufacturers in the space to make sense of the current state of play.

Here are five recent, high-profile earnings reports in the semiconductor sector and the key takeaways from each:

Taiwan Semiconductor: Strong margins and sales at the world’s biggest foundry

As the world’s largest microchip manufacturer, as measured by market capitalization, the $600 billion Taiwan Semiconductor Manufacturing
TSM,
-0.52%

is in many ways the most prominent sign of the industry’s health. This is not just because of its size, but also the fundamentals of its model. Rather than running a high-profile research shop that banks on the success of its proprietary designs, TSM is a manufacturer that specializes in custom-built chips for third-party clients who simply don’t have their own factories.

Here’s the key takeaway from TSM in a nutshell: Earnings beat expectations, and guidance was revised higher, all on the back of improving margins. Specifically the chipmaker reported gross margins of 51.3%, up from 50% the prior quarter. And looking forward, company guidance is calling for 51% to 53% margins as profitability expands further, thanks to strong demand for its services from third parties.

This dynamic is logical, given factory disruptions have enabled TSM to command a premium for operations at its facilities. But investors should be encouraged that these margins aren’t happening amid a shrinking top line. Consider that for the fourth quarter, Taiwan Semiconductor forecast revenue of $15.5 billion — well above last year’s tally of about $12.9 billion and a sign the business continues to expand on all fronts.

Shares of TSM stock are admittedly in the red year to date, but hints of strength like this third-quarter earnings performance are also a reason shares are up more than 35% from recent 52-week lows on hopes of a turnaround.

Intel: Depending on legacy chips comes with risk

Unlike TSM, branded chip icon Intel
INTC,
-0.10%

is very much reliant on its own patents and research to drive performance. And unfortunately, the Intel brand hasn’t been doing great lately.

In its latest earnings report, the chipmaker fell short on several fronts — including third-quarter revenue as well as future margin projections. Those revenue shortfalls were driven by the fact that Intel is still very much dependent on the PC business, which isn’t exactly going like gangbusters in a mobile age, but also its data center business, which is underperforming.

The worst sign of all for investors, however, may be projections of earnings and margin trouble in the near future.

Intel Chief Executive Pat Gelsinger, who took the helm just this year, told analysts in a rather active conference call that its margins might be under pressure but will remain “comfortably above 50%” and that the company is at a “pivot point” in taking its business to the next level. But skeptical investors have heard this song and dance before — and based on the massive 11% decline in INTC stock on Oct. 22, they may not be buying this narrative that all is well for a company with specific product challenges at a time of general uncertainty for the industry.

Micron Technology: Weak guidance fuels investor uncertainty

Shares of Micron Technology 
MU,
+1.85%

posted earnings at the end of September, so this company may not be as prominent as other stocks making headlines. But in many ways its fiscal fourth-quarter report was among the first data points of how the sector might respond this earnings season. And based on the fact that MU stock has given up more than 10% from its Sept. 27 high, that response seems to be rather bleak.

As with Intel, the company topped quarterly expectations but failed to offer Wall Street any reason for future optimism with its rather tepid outlook. Micron is admittedly its own flavor of chipmaker, as its business isn’t focused on processors, like Intel, but instead is reliant on data storage and memory system hardware. But the story sounds familiar to Intel’s struggles, given its recent report showing material growth last quarter but a disappointing view of the future.

Specifically, Micron’s guidance for the current fiscal quarter was earnings of $2 to $2.20 a share on sales of $7.45 billion to $7.85 billion. Analysts on average were projecting fiscal first-quarter adjusted earnings of $2.53 a share on revenue of $8.54 billion — a big disappointment, and a hint that past success won’t be as easy to come by. That’s very disappointing for some investors who expected semiconductor stocks to continue to see success as they are all but guaranteed to command a decent price for everything they’re capable of producing at present in this supply-constrained environment.

Broadcom: Leveraging scale and outsourcing

Another major chipmaker that reported earnings a few weeks back is Broadcom
AVGO,
+1.29%
,
and unlike some of the other names in the sector, it has seen a fairly nice run lately — including pushing to a new all-time high in September in the wake of its third-quarter report.

That’s because AVGO managed to post the kind of numbers that Wall Street is looking for lately — strong near-term performance, but also a robust outlook that proves Broadcom is navigating the volatile environment. Specifically, its third-quarter earnings showed a 28% jump in earnings per share, alongside a revenue forecast of $7.35 billion for its fiscal fourth quarter that comfortably topped Wall Street estimates of $7.23 billion.

The deeper reason for Broadcom’s success could come from more foundational facts about its business model, particularly AVGO’s history of aggressive growth via acquisitions and its “fabless” operation where it relies on third-party manufacturers instead of running its own foundries. On the surface it sounds like outsourcing production would be problematic in the current environment, but Broadcom’s management is clearly earning their keep by managing limited inventories. Besides, there’s no doubt that factories with limited capacity probably want to give priority to Broadcom, the No. 1 fabless chipmaker by market capitalization, rather than risk damaging important relationships with this deep-pocketed client.

There are assuredly risks to the fabless model, but AVGO is proving skilled at managing those risks — and navigating a global semiconductor shortage deftly at the same time.

Nvidia: Driven by innovation

Another fabless company that relies on its design chops instead of manufacturing prowess, Nvidia
NVDA,
+1.94%

has made a name for itself in recent years. That’s because of a few reasons: tremendous financials, including revenue that has more than doubled over the past five years, and a gravity-defying share price as NVDA stock has surged almost 10-fold since the end of 2016.

But the story of innovation at Nvidia is just as compelling as those hard numbers. For those not familiar with the stock’s history, Nvidia saw the its first big burst of growth several years ago, thanks to industry-leading graphics-processing hardware — a must-have for modern gamers. Since then, it has become a player in chips for everything from autonomous driving technology to cryptocurrency mining. And while gaming and high-performance graphics remain its biggest money-maker at present, its continuous innovation gives Nvidia investors big hopes for the future.

Earnings for this chipmaker come off-cycle with these other stocks, so we won’t get another report until early November. However the second-quarter numbers in August were impressive: 68% year-over-year growth in the top line, driven by an 85% surge in its gaming business. But what really cheered investors was the continued expansion into data center chips, and looking forward its planned acquisition of major chip design company ARM for $40 billion would ensure product innovation for many years to come.

Admittedly, NVDA faces the same short-term headwinds as much of the industry. But shares are up about 75% so far this year because investors have a lot of confidence this stock has what it takes to weather these disruptions and come out even more dominant on the other side.

Jeff Reeves is a MarketWatch columnist. He doesn’t own any of the stocks mentioned in this article.

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