Semiconductor Industry Faces Challenges and Opportunities Amid Market Shifts

Infineon Is Now Undervalued On Fundamentals And Sentiment (Rating Upgrade) (OTCMKTS:IFNNF)

Geopolitical tensions and rapid industry innovation pose risks, but significant growth catalysts in SiC production and AI power business drive bullish sentiment for FY 25 and 26. I last covered Infineon (OTCQX:IFNNY) (OTCQX:IFNNF) in June; at the time, I put out a Buy rating based on fundamental undervaluation. However, the stock has fallen around 20% in price since then. My investment strategy is now evolving to incorporate more elements of market psychology, and whilst I do emphasize fundamentals as the foundation of valuation analysis and Buy ratings, I believe that without sentiment analysis, one is exposed to high levels of potentially unnecessary losses if investing on fundamentals alone. In this analysis, I explain why I now consider Infineon undervalued both based on sentiment and discounted earnings and why, together, this opens up a very attractive entry point on high fundamental growth estimates for FY 25 and 26. I am bullish on IFNNY, much more so than in my previous analyses on the firm, due to an even lower valuation at present, making it a Strong Buy based on my research. In Q3, reported on 8/5/2024, IFNNY's revenue was a 2% increase from the previous quarter. In addition, the company mentioned that it faced a challenging market environment, leading to higher inventory levels, outlining the consensus that FY 24 will close at a significant contraction in EPS and revenue. For a contrarian value investor like myself, this represents a buying opportunity due to downward momentum at the moment, opening up alpha potential. IFNNY mentioned its "Step Up" program, where it is focusing on strengthening its structure to manage the current demand cycle and bolster its competitiveness. The new SiC manufacturing plant in Malaysia, which I will outline below, is a symbol of such infrastructure development to support the company's continued advance as economic conditions hopefully improve in FY 25 as currently anticipated on Wall Street. Infineon is currently experiencing strong demand in its automotive and renewable energy segments. The high adoption of EVs and the need for energy security continue to drive demand for semiconductor components. Furthermore, IFNNY has a strong position in the Chinese market, a significant growth driver. Additionally, in FY 24, IFNNY expanded its production capacity with the Kulim SiC fab, which is expected to be ready by autumn 2025; this enables a revenue capacity of over €1B. In FY 24, IFNNY achieved 50% revenue growth in SiC, so this makes me very bullish for FY 25's increased capacity. Furthermore, IFNNY has an emerging AI power business, which is exceeding expectations; sales for this segment are expected to double in FY 25 to over €400M. The growth is, of course, supported by the increasing demand for data center power, which is a critical area for semiconductor applications. The consensus is that IFNNY will achieve EPS growth of 17% in FY 25 and 26% in FY 26 and revenue growth of 9.5% in FY 25 and 12% in FY 26. That's a lot of reason to be bullish when FY 24 saw a 29.5% contraction in EPS and a 7.2% contraction in revenue. The price has also contracted, and the market has not priced in FY 25 growth yet: I mentioned in my previous analysis of IFNNY that it is undervalued when assessing the company through discounted earnings analysis. However, I think it is largely true that the market doesn't much care for this type of fundamental valuation analysis. Instead, it is nice to know that the company is trading below its intrinsic value on an earnings basis (the same can't be said for its DCF intrinsic value because of its high capital intensity affecting its free cash flow). In my last analysis on IFNNY, I outlined that it was potentially 40% undervalued on a 20Y horizon: As the stock has now dropped in price by 20% since then, it has become even more undervalued. In this analysis because I put emphasis on market psychology more than anything in my valuation analyses, I am focusing on a price target approach for a more nuanced perspective on IFFNY's price action over the next year. IFNNY currently has a PE ratio without non-recurring items of 15.5, compared to a 10Y median of 21. Furthermore, the Wall Street consensus is that IFNNY will have EPS without NRI of $2.37 in FY 25 end. Therefore, if the market prices this into the stock one quarter early, which I find likely, and the PE without NRI expands to 19 on bullishness about new growth, especially gearing up to FY 26, where the Wall Street consensus is that IFNNY will achieve $2.98 EPS without NRI at year-end, then the stock could be worth $45 in 12 months. This indicates a ~37.5% upside in 12 months. IFNNY is also well-diversified geographically, so a slowdown in the American economy over the next few years would not mean that it is necessarily severely impacted, as much of its revenue is generated in Asia. IFNNY operates on a complex, global supply chain that is susceptible to disruptions from natural disasters, pandemics, and geopolitical events. The company is implementing digital tools to enhance resilience in this area, but a fully digital supply chain presents challenges in standardizing processes and secure data sharing. It also relies on a network of raw materials and components suppliers, and during this time of heightened geopolitical uncertainty, there is a greater chance of outlier events causing significant and unwarranted downside to IFNNY, more so than many other companies, especially in service-based industries. If IFNNY faces ongoing trade tensions, particularly between major economies like the US and China, this would be a significant problem for IFNNY, as it operates in both the West and the East. Political instability in the Middle East and Eastern Europe right now are areas that show the risk here, which is currently being kept under control but could develop and cause issues in supply and demand. It is these types of geopolitical events that, I believe, have the highest risk of reducing fundament growth for IFNNY in FY 25 and 26, reducing the alpha potential of my thesis. The semiconductor industry is also prone to rapid innovation, and companies like STMicroelectronics (STM), MediaTek, and Odyssey Semiconductor Technologies pose a significant threat to IFNNY's expansion. Furthermore, with new technology like 6G, quantum computing, and AI hardware acceleration, the semiconductor industry and the infrastructure semi companies are supplying are changing rapidly. Over the long term, I believe IFNNY faces significant market share erosion threats from new entrants and also from larger semi companies that consolidate around high-demand areas like AI and data center operations. For example, more Nvidia (NVDA)-style moats could spell trouble for the long-term growth trajectory of IFNNY. In my opinion, IFNNY is cheap right now. It is even more deeply undervalued based on DE analysis compared to my last thesis, but it is also undervalued based on valuation multiples and shows momentarily depressed sentiment, which is worth capitalizing on, based on my analysis. As a result of the current valuation and growth for FY 25 and 26, which looks set to be very promising on SiC capacity expansion and other catalysts, IFNNY is currently a Strong Buy with returns of ~37.5% possible in just 12 months.

Infineon: Still Positive On The Medium-Term Growth Outlook (IFNNY)

The upside case remains attractive even after adjusting growth estimates downward. Investment action I recommended a buy rating for Infineon Technologies AG (OTCQX:IFNNY) when I wrote about it last December, as I believed the underlying demand was robust and that the valuation should be well-supported by these demand tailwinds. Based on my current outlook and analysis, I continue to recommend a buy rating. My key update to my thesis is that I believe the tough part of this down cycle is over, and IFNNY should see growth over the coming quarters, backed by strong underlying secular trends. At the current share price, even with my revised model assumptions, the upside is still quite attractive. Review IFNNY reported 3Q24 earnings last week, which saw total revenue of EUR3.7 billion, gross profit of ~EUR1.5 billion, EBIT of EUR519 million, EBITDA of EUR989 million, and recurring EPS of EUR0.37. On a growth basis, revenue fell by ~9.5% in 3Q24, a slight improvement from the ~12% decline seen in 2Q24. Gross margin also improved from 38.6% in 2Q24 to 40.2% in 3Q24, although it is still down ~420 bps vs. 3Q24. The same trend was seen in EBIT, where the EBIT margin expanded 30 bps sequentially to 14% but is still down from 24.4% in 3Q24. Certainly, results have not been great since I last wrote about IFNNY. Year-to-date [YTD] revenue is down ~9% vs. my expectation for 7% growth in FY24. YTD EBITDA margin also did poorer than I modeled (28.2% vs. my model of 35.1%). As such, I get why the share price has seen heavy pressure since the start of the year. However, I am not ready to throw in the towel as it appears that IFNNY has moved past the bottom of this cycle as 3Q24 marked the first quarter of positive sequential growth since the start of FY24, and management guided for sequential growth in all segments in 4Q24. Importantly, it was noted that the worst of the inventory correction is now in the rear mirror (per management comments). I am cognizant of the fact that 1 quarter of sequential growth (3Q24) and 1 quarter of positive guidance (4Q24) are not sufficient to prove that a turnaround trend is happening. However, I am confident that over the next few quarters, IFNNY will see a growth turnaround for three reasons: The overall semiconductor market is expected to see growth in 2024 and 2025, which IFNNY will benefit from given its leading market position. OEMs are shifting from mature nodes (>28 nm) to more powerful nodes (<28 nm), an area where IFNNY is seeing very positive win rates (implying market share gains). This is a good quote from the 3Q24 earnings call to back this view: "I think we will see for the next years continuous market share gains because we are just now in the transition from the 65 to the 40-nanometer generation, which is now taking over in terms of volume and our design wind pipeline, confirmed design wins or rewarded design wins is even stronger in the 40-nanometer generation compared to 65. So, I think we are set up for more market share gains going on. And I also see a good design win trajectory already at this point in time playing out in the 28-nanometer node. So we are pretty confident on that business." I believe everyone can agree that demand for AI-related solutions/applications is going to continue growing from here, and this is a very positive trend for IFNNY. This increases demand for advanced power solutions, where IFNNY is already seeing strong traction so far. In the call, management noted: "we are accelerating our AI power business with significant ramp-ups for several customers, some of which already deploy our innovative vertical power delivery solutions" Given that automotive is IFNNY's largest segment, I can understand why some investors may be worried about the weak EV demand environment in the US. This is a fair concern, but remember that China continues to see strong EV demand, and IFNNY has more revenue exposure to China than the US. Importantly, IFNNY is the leading player in China, which provides investors with exposure to the fastest-growing EV market in the world. Looking at the global adoption of electric vehicles, regional divergence remains pronounced. China sees healthy consumer demand, which helps us, particularly given our number one automotive market position there. 2Q24 call Hence, if you were to ask me, will IFNNY see growth recover in the next quarter? I think it's going to be hard to answer. But will IFNNY see overall growth over the next few quarters? I believe the answer is yes. Assuming this assumption is right, I expect IFNNY to see very strong EBITDA growth as the topline recovers and the cost structure gets lowered. I have already discussed my views on revenue above, so I will focus on cost structure here. There are two aspects to take note of here. Firstly, IFNNY will see EUR800 million of lowered costs at the gross margin line as these underutilization charges go away in FY25 (when utilization recovers). Secondly, IFNNY will start to benefit from its current cost-cutting program in FY26. For those that are unaware, IFNNY launched its "Step Up" program in 2Q24 to target a leaner cost structure, and so far, things have progressed well with the business already winding down two backend facilities in Asia, writing down equipment in a facility in Regensburg, and now expecting to reduce headcount over the next few quarters. Valuation After the share price decline so far, I think the upside case remains attractive even after adjusting my growth estimates downward (reflecting the poor YTD performance and any lingering weakness for the rest of FY24). FY24 performance is likely to come as per guidance (-8%) given the visibility that management has and the YTD performance so far. In FY25, the business should see a strong growth recovery. As per historical performance, after a year of negative y/y growth, the following year's growth tends to be >10%. Assuming 10% for FY25, I got to a revenue figure of $16.5 billion. As for FY26, I assumed 7% growth (pre-covid growth levels). I have also tapered down my EBITDA margin expectation as revenue size is smaller (but should still improve from FY24 given the larger revenue base vs. FY24 and cost savings). Risk IFNNY now needs to show the market that the trough is over and growth will turn positive over the coming quarters. This is basically a "show me" story now, which means if IFNNY fails to meet expectations or misses its own guidance again (it missed in 1Q24 and 3Q24), the stock will likely get punished again. In other words, pinpointing the exact timing of growth recovery is a risk that investors have to bear when going long the stock today. Final thoughts My recommendation is a buy for IFNNY. YTD, the business performance has been poor, with revenue declines and margin compression, but I believe IFNNY will see growth over the next few quarters. Firstly, the worst of the inventory correction appears to be behind us, and the company is demonstrating early signs of recovery. Furthermore, IFNNY has strong market positions in key growth areas that bode well for growth. Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. I consider an investment ideal if it performs its core business in a sector projected to experience structural (organic) growth in excess of GDP growth over the next 5-10 years; profits from sustainable competitive advantages that translate into attractive unit economics; In the hands of competent, ethical, and long-term thinkers; with a fair valuation Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Qualcomm: Navigating Its Post-Earnings Dip - A Compelling Investment Opportunity (QCOM)

The market may potentially undervalue the stock based on price-to-free cash flow. When I recommended QUALCOMM (QCOM) on April 1 and May 14 this year, it looked like a well-timed decision for a few months. The stock reached a 52-week high of $230.63 on June 18, up 34.30% over my April buy recommendation and 25% over my May recommendation. It has been mostly downhill from there, as stocks perceived as Artificial Intelligence ("AI") beneficiaries fell out of favor. Despite investor sentiment turning against the company, the case for investing in Qualcomm remains on track. The company should be a massive beneficiary of AI moving to local devices, a potential refresh cycle in PCs and smartphones providing a tailwind, the opportunity to provide chips to the auto industry increasing, and the company having excellent earnings and free-cash-flow ("FCF") growth. Additionally, after its +30% drop since June 18, the stock sells at a much better valuation. Thus, I still recommend that growth investors consider buying Qualcomm. This article will discuss why the stock declined after earnings and why investors should focus on the company's new growth engines. It will also review the earnings report, the stock's valuation, and why I still think it's a buy. Qualcomm's traditional handset business is still the company's most prominent business, ending the third quarter at $5.9 billion. However, as this article will discuss later, the days when the company generated explosive revenue growth in the mobile handset business are probably over. Management started developing additional growth revenue streams several years ago, the first being automotive. Now is the time for investors to start paying attention to the company's auto business. By the end of this decade, the handset business may cease being Qualcomm's most prominent business. Since November 2021, the company has forecast $4 billion in automotive revenue by FY 2026, reaching $9 billion by FY 2031. Management confirmed those numbers in the third quarter FY 2024 earnings call. Chief Executive Officer ("CEO") Cristiano Amon said, "We expect, given the size of our [automotive] pipeline, we talk about $4 billion in '26. We talk about $9 billion toward the end of the decade." CEO Amon also believes there is an upside to the company's original automotive projections. He said on the third quarter earnings call: An upside is what Gen AI is doing in automotive. Gen AI use cases, especially using large language models for audio. It was a great user interface for were behind the wheel. We're starting to see a lot of interesting use case being developed. That upside to our model, it could be an upgrade of [semiconductor] content in the digital cockpits that we have in. If the company meets its auto estimates, this revenue stream may be its fastest-growing area for the next several years. Qualcomm's total revenue grew 11% year-over-year to $9.39 billion, helped by the smartphone market's recovery. However, the days of high-octane revenue growth in the smartphone handset market are likely over. Qualcomm's annual total revenue has only grown at a 9.6% compound annual growth rate ("CAGR") over the last five years, mainly due to the smartphone market deteriorating in 2023. Although the revenue growth slowdown in the smartphone business over the previous several years is primarily due to a cyclical downturn, the smartphone market is unlikely to go back to the era of 2000 to around 2013, the transition from 3G to 4G, where Qualcomm was able to generate above-average revenue growth. Some thought the transition between 4G and 5G would rejuvenate growth in the smartphone market, but that has yet to occur. The smartphone market has matured. Almost everyone who wants a smartphone already has one. Consumers have been slower to adopt 5G, likely because its main benefits, such as better latency and speed, have had a slow rollout period. The lower-end version of 5G provides very few additional advantages over 4G. Additionally, Qualcomm hasn't benefitted as much from the 4G to 5G transition because the smartphone chipset market has become much more competitive. The company's overall revenue growth tanked when the smartphone market declined in 2023. The smartphone market only began to show signs of life at the end of 2023, and the market is still recovering. International Data Corporation's Worldwide Quarterly Mobile Phone Tracker stated in a July 15, 2024 article: Global smartphone shipments increased 6.5% year-over-year to 285.4 million units in the second quarter of 2024 (2Q24). Although this marks the fourth consecutive quarter of shipment growth and builds the momentum towards the expected recovery this year, demand has yet to come around in full and remains challenged in many markets. The mobile phone market has yet to recover fully but has grown enough that Qualcomm is benefiting from the tailwinds. The following table shows that the company's handset revenue grew 12% year-over-year, even with analysts' consensus estimates. The market was likely unimpressed that the company did not exceed analysts' expectations, which is one probable reason the stock price was lackluster after earnings. Some investors have yet to adjust to the handset business no longer being the company's primary growth engine. The new growth engine is automotive, which this article discussed in the previous section. The above table shows that automotive is the fastest growing portion of the company at 87% year-over-year. The best part is that management expects 50% year-over-year revenue growth for FY 2024, which is a solid outlook. Investors should also look to the IoT (Internet of Things) revenue stream, which will eventually become another growth engine. AI PC revenue will likely be included in the IoT revenue stream. Qualcomm's IoT revenue declined 8% year-over-year to $1.36 billion. The IoT market is currently in a downturn that it should be coming out of soon. According to IoT Analytics, growth in the IoT market is decelerating this year and should reaccelerate in 2025. If that research is valid, investors should expect revenue growth to pick up in QCT's (Qualcomm CDMA Technologies') IoT market in FY 2025. The QCT segment designs and manufactures semiconductors for applications such as smartphones, computers, automotive, and IoT. However, despite two new growth engines, Qualcomm's days as a high-revenue growth company are likely over. Analysts expect the company to only grow revenue at an 8.42% compound annual growth rate over the next three years. The thesis for investing in this company has shifted from investors looking for high revenue growth to investors wanting to see high earnings and free cash flow ("FCF") growth. The company spent 2023 in cost-cutting mode, culminating in the layoff of 1,258 employees in California. Third-quarter total costs and expenses grew 8.2% year-over-year, slower than third-quarter revenue growth, resulting in GAAP (Generally Accepted Accounting Principles) operating margin expanding 207 basis points to 23.64%. In the third quarter of FY 2024, operating income grew 21.83% to $2.22 billion. Qualcomm emphasizes a metric named earnings before taxes ("EBT") over operating income because the company operates in various global tax jurisdictions. EBT may give investors a better idea of the company's profitability over operating income because although it eliminates the effect of taxes, it still considers non-cash expenses such as depreciation & amortization (which can reduce taxable income) to provide a broader view of profitability before taxes. In the third quarter of FY 2024, the total EBT margin was up 347 bps to 24.26%. The QCT EBT margin was up 3 points to 27%, which was at the high end of the company's guidance range. The automotive revenue stream is mostly driving this QCT margin improvement. The QTL (Qualcomm Technology Licensing) segment EBT margin was up 4 points to 70%. QTL is the company's intellectual property licensing division. Diluted earnings-per-share ("EPS") were up 18% year-over-year to $1.88, beating analysts' estimates by $0.09. Qualcomm's cash from operations ("CFO") to sales ratio was 36.53%, its highest level in ten years. This number means the company converts every $1.00 in sales into $0.37 in cash. The higher this ratio, the greater the potential for generating FCF. The following chart shows that the company has lowered capital expenditures ("CapEx") on an absolute basis since the end of 2022. The lower the CapEx spending, the greater the potential for FCF growth. Although Qualcomm has some in-house manufacturing of vital components, it is mainly a fabless chip manufacturer, which means it outsources most of its chip manufacturing to third-party foundries. Therefore, it spends less on CapEx than an integrated device manufacturer such as Intel (INTC), which makes most of its chips within its own foundries. The chart below shows that Qualcomm spends far less on CapEx in relation to revenue than Intel, meaning it has a higher potential for generating FCF. The following chart shows that the company's FCF growth has exploded higher since July 2023 -- exactly what Qualcomm investors want to see. One of the best ways to value a stock is FCF growth, which some consider a better indicator of value than EPS growth, as companies can manipulate EPS through various accounting tactics. FCF represents CFO minus CapEx and is less susceptible for companies to manipulate. The valuation portion of this article focuses more on FCF-based valuation methods than other valuation methods. Qualcomm used some of its growing FCF to repurchase 7 million shares of stock for $1.3 billion during the June quarter and paid $949 million in dividends. It also reduced its long-term debt. The chart below shows that Qualcomm has reduced its debt from over $16.8 billion at the beginning of 2023 to $14.55 billion at the end of its June 2024 quarter. The following chart shows that the company's cash stockpile has dropped significantly from over $36 billion in 2018, as the company first used the cash to pay down long-term debt and repurchase stock that year. Later, in 2023, the company used some of its cash stockpiles to help it survive the downturn in the smartphone and IoT markets. The company is now using some of its growing FCF to rebuild its cash stockpile, which now sits at $13.03 billion at the end of the June quarter. At the end of the June quarter, the company had a net debt of $1.522 billion and a TTM EBITDA of 11.565 billion. Its net debt-to-EBITDA ratio was 0.13, meaning it had the resources to cover its debt obligations. Although the company topped analysts' consensus forecasts for revenue and adjusted EPS and exceeded forecasts for guidance, the stock dropped 9% the day after earnings. The biggest issue Qualcomm had going into its third-quarter earnings was the growing consensus among the media, analysts, and investors that the amount invested in AI infrastructure is outpacing the revenue that companies are generating from AI applications. It's what Sequoia first described in 2023 as the $200 billion question and later updated in June 2024 as the $600 billion question. In other words, some believe that the investment in AI infrastructure has formed a bubble, a massive headwind against Qualcomm's stock rising after earnings since it is a potential beneficiary of the AI infrastructure build-out. The company would have had to turn in a perfect quarter for the stock to increase, but it did not. The earnings report brought up some company-specific risks the market became concerned about, including a lower-than-expected outlook for the company's December quarter. Some analysts went into earnings with high expectations for revenue growth in the company's December quarter, and when the company's revenue guidance came in much lighter than analysts' forecasts, enthusiasm for the stock waned. Investor's Business Daily stated, "JPMorgan analyst Samik Chatterjee said investors had been primed for double-digit revenue growth in the December quarter. But Qualcomm predicted mid-single-digit growth in the quarter, its fiscal Q1, on flat smartphone growth, he said in a client note." Management didn't actually forecast "mid-single-digit growth in the [December] quarter," however, the Chief Financial Officer ("CFO") Akash Palkhiwala did say in the company's third quarter FY 2024 earnings call, "Consistent with our long-term financial planning assumption of largely flat handset units, we continue to estimate global 3G/4G 5G units in calendar '24 to be flat to slightly up on a year-over-year basis," which implies a lackluster December quarter. Flat smartphone growth ignited existing fears about the potential loss of Apple (AAPL) as a customer and Chinese smartphone manufacturers potentially reducing their reliance on Qualcomm over the next several years. Some investors are also anxious about when AI Personal Computer ("PC") revenue growth will appear in the company's results. During the earnings call, one analyst asked how many AI PC units the company would sell in the holiday period. CEO Amon said about the AI computer during the third quarter earnings call (Emphasis added): It's a new version of Windows, the Copilot+ is a new architecture with an ARM compatible. We expect that, that will ramp over a period of time. But what we have seen in the market right now with the 20 models that can launch is exceeding our internal targets. Some models, as I mentioned in my prepared remarks, had sold out. And I think we should expect that will continue to be a crescendo, slow and steady, as the market transitions. The company only launched this business in June, and investors should not expect meaningful revenue to appear for a few quarters. When the AI PC business is fully up and running, management expects it to be its second most potent growth driver. The following table shows Qualcomm's EPS estimate, estimated EPS growth rate, and forward price-to-earnings (P/E) ratio. One simple way to value a stock is to compare its analysts' EPS estimated growth rate to its forward P/E ratio. If the two numbers match, the market fairly values the stock. It would be like the company had a forward Price-to-Earnings-to-Growth ("PEG") ratio of one, which many consider fairly valued. If the EPS estimate growth rate exceeds the forward P/E, the market undervalues the stock's potential earnings growth. If the EPS estimated growth is lower than the forward P/E, the market overvalues its potential earnings growth. According to those rules, Qualcomm looks undervalued based on FY 2024 metrics and would have a forward PEG ratio of 0.86. If the stock hits its EPS estimate of 10.03 at the end of the September quarter, which would be a 19.04% EPS growth rate, its fair value would be $190.97, up 16% above the August 8 closing price. Let's consider Qualcomm's reverse discounted cash flow ("DCF"). The terminal growth rate, the rate at which I expect company's FCF to grow in perpetuity, is also an expectation of the company's growth rate. I use a terminal growth rate of 2%, meaning I believe that the company will grow at a similar rate as the U.S. gross domestic product over the long haul. I use a discount rate of 10% because I consider Qualcomm's risk normal. A higher discount rate would mean that I consider the risk higher than normal. A lower discount rate would mean that I believe the risk was lower than normal. I also use the company's levered FCF in the following reverse DCF. According to the assumptions I used in the above reverse DCF, Qualcomm would only need to grow FCF at a 2.8% annual growth rate to justify the current stock price. However, it's doubtful that the company will maintain an average FCF margin of 33.65% over the next ten years. The stock is cyclical, and despite the company now growing new revenue outside the highly cyclical smartphone market, FCF should still exhibit cyclicality in the IoT and auto market over time. The stock has had a median levered FCF margin of 22.57% over the last ten years. Assuming it can maintain an average FCF margin of 23% over the next ten years, it would need revenue to grow 9% annually over the next ten years to justify the current price. Assuming that its AI chip business helps it generate an average FCF margin of 25% over the next ten years, it would need revenue to grow 7.8% annually over the next ten years, which is feasible for this mature company entering new growth markets. As stated earlier in the article, Qualcomm only grew revenue at a 9.63% CAGR over the last five years. I expect that handset revenue may deteriorate and become a drag on the higher-growing revenue streams. The revenue growth rate should settle at around 7 to 8% annually over the next ten years. According to this analysis, the current stock price is near fair value. Be cautious about fully accepting the assumptions I made in the above reverse DCF of Qualcomm because reverse DCF and DCF analysis on cyclical stocks can often be highly inaccurate. There is high uncertainty about what the AI opportunity will do to Qualcomm's revenue growth, FCF margin, and FCF growth over time. Additionally, there is high uncertainty over how fast and when handset revenue might drop off. Over the next one to two years, FCF should continue growing as the adoption of AI PCs boosts the PC refresh cycle, the company continues capturing business in autos, the IoT business returns to growth, and people begin buying new AI-enabled smartphones. Qualcomm's price-to-FCF is 14.03, well below its five- and ten-year median of 19.05 and 18.56, respectively. If the company traded at its ten-year median, the stock price would be $206.57, up 32.31% above the August 7 closing stock price of $156.12. If the stock traded at its five-year median, it would be $212.03, up 35.8% above the August 7 stock price. The following chart shows the company grew trailing 12-month FCF by 27.11% since the start of 2024. The following chart shows that the stock price only grew 14% over the same period. Suppose FCF maintains a solid double-digit growth rate, and the macroeconomy doesn't deteriorate further. In that case, the market will likely soon respond by driving the stock price higher until it reaches its median price-to-FCF. This scenario is likely if the Federal Reserve follows through on its expectation that it will reduce interest rates in September. Although investors rightly worry about Chinese smartphone revenue because it makes up around 40% of the company's revenue, things might not be as bad as it seems. This worry about a loss of Chinese revenue has been around for a few years. Yet, Qualcomm's figures in the third quarter suggest that investors hold off on doomsday scenarios of massive revenue loss in China happening any time soon. CFO Palkhiwala said during the third quarter earnings call that Qualcomm has "greater than 50% year-over-year growth in revenues from Chinese OEMs." Chinese OEMs may take quite a while to find alternatives to Qualcomm chips because Chinese semiconductor manufacturers like SMIC are disadvantaged by not having access to the latest chip technology from companies like ASML Holding (ASML). Perhaps one day, Chinese chip manufacturing technology will catch up, but it may take several years or more for a Chinese company to manufacture chips at the same level or better than Qualcomm. The worries over the loss of Apple revenue may be overblown, too. For a while now, the company hasn't included Apple revenue outside of its existing agreements in its guidance. CEO Amon said in this quarter's earnings call (emphasis added): As it relates to our business with Apple, we still operate with the framework that we provided to you all. I think when we extended the chipset agreement, and we expect to be operating within that. We have no new update to provide it everything above what we said before is an upside. So, we don't have that in our financial planning assumptions above what we had disclosure. Investors who understand that AI and Qualcomm's new automotive and IoT growth engines will drive margin expansion, revenue, and FCF growth moving forward should consider investing in the stock. The company's growing FCF should allow it to reduce debt, repurchase shares, and increase its dividends, thereby increasing its value over time. The recent decline in the stock price gives investors a decent entry point. I reiterate my buy recommendation for Qualcomm.

High Potential, Higher Valuation - AMD In The AI Spotlight (NASDAQ:AMD)

Given the stock price that doesn't appear undervalued, AMD receives a "Hold" rating. It was difficult to lose money in the semiconductor industry until very recently. Stocks have been rallying over the last year, with Nvidia (NVDA) leading the way for other players. The sector has become almost too hot and made investors hesitate before touching any of these names. The recent tech sell-off might have changed the story. Valuations still seem expensive, but some investors view this decline as an investment opportunity. The long-term potential of these companies is huge, although they may face short-term headwinds. One of these companies is Advanced Micro Devices (NASDAQ:AMD). Similar to Nvidia, it offers CPUs, GPUs, and other processors to data centers, enterprise clients, and consumers. Despite the concerns around "losing that AI race", it has benefited significantly from technological developments as one of the leading suppliers. There are many positive developments including market share gains, sustained high demand, and strong guidance. However, the current valuation implies that the expectations are too high. The stock doesn't appear undervalued and might decline significantly if AI spending by big technology companies drops. I believe the risk-reward profile is not worth it. Therefore, AMD gets a "Hold" rating. As a well-known company, AMD may not need an introduction. However, I like to go over the business fundamentals. Advanced Micro Devices is a global semiconductor company, specializing in processing units. It offers CPUs, GPUs, accelerated processing units, data processing units, AI accelerators, and more. The company has four reportable segments, which are also its end markets. Historically, its largest end market was Client, where it sold CPUs incorporated into computing platforms. These are different enterprises that need AMDs solutions to build their own computing systems. Although revenue surged in 2021, it has been declining since. With this decline, Gaming became the largest segment. It provides graphics processing solutions that increase the speed of rendering images. AMD benefited greatly from the surge of demand post-pandemic. People were stuck at home, and demand for gaming picked up. As new games with better graphics were released, consumers needed better computers, which had AMDs chips in them. However, this surge in demand was also short-lived. Now, the focus has shifted to artificial intelligence and data centers, and for good reason. As the need to store and process data increases thanks to the developments in artificial intelligence, data centers need more chips that are specifically designed for machine learning and artificial intelligence purposes. Nvidia might be the first supplier that comes to mind, but AMD also benefited a lot from this surge. Revenue from data center demand increased significantly since the pandemic. This was the largest segment in terms of revenue in FY23. While the revenue mix has been shifting from client to first Gaming and then to Data Center, the Embedded segment has grown considerably largely due to the Xilinx acquisition in 2022. This segment includes embedded chips that are used in various end markets including automotive, industrial, test, medical, aerospace and defense, networking, and security. As companies develop increasingly sophisticated technologies, the demand for more advanced chips grows. The charts below show the change in revenue and operating margin by segment. Currently, the most profitable segment by far seems to be Embedded. Additionally, here is a summary of the products provided through these four segments. The stock has surged more than 200% between October 2022 and March 2024. However, it has declined by around 32% since then. This drop can be attributed to certain company-specific factors and industry-wide trends. Let's talk about the industry first. Semiconductor companies have been performing very well since the beginning of 2023. The S&P 500 Semiconductors Index is up nearly 200%, while the S&P 500 is only up 39% over the same period. However, this semiconductor index is down 15% since July 2024, indicating that the market may be concerned about the future of these companies. This was one of the reasons for the big tech sell-off we have been seeing. The market is worried that technology companies may have overinvested in artificial intelligence and that this significant CAPEX may not be translating into earnings. Top technology companies like Alphabet (GOOGL), Microsoft (MSFT), and Amazon (AMZN) have been the largest investors in artificial intelligence infrastructure thanks to their strong balance sheets. If these companies begin to doubt the potential of AI as a major earnings driver, they may cut their spending, which would decrease demand for AMDs products. Additionally, the weakening consumer may eventually impact big tech companies like Amazon, potentially leading them to cut AI spending. If AI CAPEX normalizes, growth projections for Advanced Micro Devices could be revised downward. Furthermore, some analysts and investors believe that AMD has been losing the AI race. Although the stock has overperformed the S&P 500 since 2023, it significantly underperformed Nvidia and the rest of the semiconductor space. The market is not wrong in thinking that it has not benefited from AI to the same extent as Nvidia. Although there is some truth to these arguments, currently, the short-term outlook seems more positive for the company. Let's examine if the market is right in being concerned about the issues mentioned above. Firstly, overspending is a valid concern. Although the possibilities with AI might be huge, it is not easy to monetize. I discussed the question "Is AI a product or a feature?" in a recent article. The answer to this question may vary depending on what the company is trying to achieve with AI, but the truth is that companies have yet to successfully monetize it so far. Apple's (AAPL) new AI features are nice but are probably not resulting in a massive increase in sales, Microsoft is yet to introduce a product that will significantly drive earnings, Meta's AI hasn't achieved the popularity of ChatGPT, and Google's initiatives seem to produce similar results as those of Apple's. This is not promising for the future of AI investments. Unless these companies find a way to monetize AI effectively, they might reduce their spending. This hasn't been the case so far. Despite concerns, big tech continues to invest in AI. Goldman Sachs predicted that big tech companies will spend over $1 trillion on artificial intelligence in the next five years, and these companies have told investors that the spending will continue. Despite the ongoing hype around AI, I believe if these companies fail to properly monetize it to drive earnings higher soon, the overinvestment in AI will become a bigger issue in the eyes of investors. It doesn't seem likely in the short term, but there is a chance this spending will decline and so will the demand for AMDs products for data centers. Secondly, it is a fact that AMD did not achieve the growth numbers Nvidia did. However, now, it seems to be increasing its share in the chip market. The latest reports suggest that the company is among the winners in the consumer electronics space. Although this may not be as exciting as data centers, this market share gain may be one of the catalysts for investors, boosting the stock's performance to align more closely with the rest of the semiconductor industry. Finally, the company announced strong quarterly results in Q2 2024. The company slightly beat revenue and EPS estimates. Year-over-year revenue growth in data center and client segments was impressive and management appeared happy with the results. Non-GAAP gross profit was up 16% and operating income was up 18% year-over-year. AMD has announced new gen products and innovations. Additionally, the company initiated Q3 guidance. Management expects revenue to be around $6.7 billion vs. the consensus of $6.6 billion, and Non-GAAP gross margin is expected to be around 53.5%, flat from Q2. On the downside, gaming and embedded revenue were down significantly as the decline continued. Overall, it seems like the market had mixed feelings about the results, as the stock is down 1% since earnings were released. I will be using the DCF method to calculate the fair value of the company. I believe my assumptions are relatively optimistic. For this valuation, I am pricing in continued strong revenue growth and sustained high earnings margin. For the DCF model, I am using a terminal growth rate of 3%, slightly above long-term inflation targets, a long-term risk-free rate of 2%, a market risk premium of 5.7%, and the stock's 5-year equity beta. I handle cash differently. I believe shareholders have a claim on excess cash, but cash that will be used for operating expenses during the year should not be included in the valuation. That portion of cash is operating that investors cannot claim. Using the assumptions above, we find an equity value of $185 billion, translating to a target share price of $113.21. This implies a 17% downside at the time of this article's writing. As I mentioned in the introduction, the semiconductor space has been generous to investors thanks to the advancements in AI and investments in data centers. Although consumers seem to be weakening, spending on AI continues, and chip designers continue to benefit. Advanced Micro Devices has been benefiting from this trend, although not to the extent as Nvidia. The market has been concerned about the competitive AI race, potential overspending on AI, and the possibility that this spending will decline, hurting AMDs sales. Although these companies seem to continue investing in AI, they need to start monetizing these investments to sustain this level of spending. AMD announced strong results for data center solutions for now, and I would expect this to continue for at least another quarter, but we will need to track the AI CAPEX in upcoming quarters. Although I believe AMD has a strong position in the industry and may continue to benefit from this AI CAPEX, the market has very high expectations from the company. Even with sustained high revenue growth and high earnings margin expectations for upcoming years, the stock price seems overvalued. That is why Advanced Micro Devices receives a "Hold" rating. I will keep tracking the AI spending and its impact on the company and may revise this rating accordingly in the future. For now, I believe investors should be cautious.

Super Micro Computer Q4: Inventory Doesn't Lie (NASDAQ:SMCI)

Looking for a portfolio of ideas like this one? Members of Envision Early Retirement get exclusive access to our subscriber-only portfolios. Learn More " SMCI stock Q4 recap My last article on Super Micro Computer, Inc. (NASDAQ:SMCI) was a preview of its FY Q4 earnings report. That article was titled "Super Micro Computer Q4 Preview: A Swing Trade Setup (Technical Analysis)" and was published shortly before the release of its Q4 earnings report ("ER") on August 6, 2024. As the title suggests, the article is more oriented toward the near term (as a swing trade) with an emphasis on its recent technical trading patterns. With the release of its Q4 ER, I think it would be helpful to write this follow-up article with a focus on its business fundamentals, especially the new developments reported in its ER. Meanwhile, I will also switch my perspective from a short-term swing trade to the next ~2 years or so. In a nutshell, what I see is an excellent GARP (growth at a reasonable opportunity) for the next few years. My investment approach with high-growth stocks is largely shaped by the thinking of Peter Lynch (I learn from the best). And as you will see in the remainder of this article, SMCI's Q4 earnings remind me of Lynch's wisdom on the use of inventory data. Despite all the unevenness in its results, its inventory sits at near a record low, providing a reliable signal in my view of the robust demand for its products. After all, inventory does not lie. Before further diving in, let me first quickly recap its Q4 results to better prime the subsequent discussion. As just mentioned, Super Micro Computer's Q4 results are a bit uneven. Revenue came in at $5.31B, ahead of consensus estimates (by $10M) and translated into a whopping annual growth rate of +143%. However, its bottom line is under some pressure (more on this later). The GAAP EPS dialed in at $6.25, missing consensus estimates by a sizable margin of $1.56. There are also some signs of margin pressure due to rising OPEX. The market responded quite negatively, and its stock prices suffered large corrections after the ER. Looking ahead, the company expects a robust growth curve, as seen in the next chart below. To wit, its Q1 FY25 revenue guidance points to a range of $6.0B to $7.0B, translating into an annual growth rate of 183% to 230%. For full-year FY2025, the guidance range is $26.0B to $30.0B, translating into an annual growth rate of 74% to 101%. Next, I will explain why I think it is very likely that the company will materialize such large growth, judging by its inventory data. SMCI stock: Q4 inventory in focus As aforementioned, my investment approach with high-growth stocks like SMCI has largely been shaped by the wisdom of Peter Lynch, especially on the insights provided by the inventory data. For cyclical stocks like SMCI, the accounting earnings can fluctuate significantly and can cause investors to overact. Given the unevenness of SMCI's Q4 numbers, I found his following insights on inventory data particularly relevant: To start, unlike many other financial data that are more open to interpretation, inventory is one of the less ambiguous financial data. Lynch also explained why inventory levels can be a telltale sign of business cycles. Especially for cyclical businesses, inventory buildup is a warning sign, which indicates the company (or sector) might be overproducing while the demand is already softening. Conversely, depleting inventory is a sign of strong demand. Specific to SMCI, despite the EPS miss and the margin pressure, its inventory sits at near record-low levels. More specifically, as illustrated by its earning slides below, the days of inventory outstanding (DOIO) were only 82 days in Q4. This is 10 days lower than the previous quarter (and helped to shorten the cash conversion cycle by 2 days QoQ also). To provide a broader context, the chart below shows SMCI's inventory in absolute dollar amount (top panel) and in days of inventory outstanding (bottom panel) in the past 5 years starting in 2020. The top panel shows that SMCI's inventory has been steadily increasing since 2020, reaching a peak of around $4.4 billion in the last quarter. However, inventory growth is not a concern whether the business is growing at the same pace or, even better, at a faster pace. And the latter is what has been happening to SMCI. As seen in the bottom panel, SMCI's DOIO has been trending down overall, despite some fluctuations. Its current DOIO of 82 days is not only significantly below the historical average of ~100 days but also close to the lowest levels historically. Such a low inventory is a telling sign of the demand for its products, in my view. Indeed, I see several strong growth catalysts ahead, driven by the booming demand for AI solutions. According to a report from the 650 Group, the AI market is expected to expand from $41 billion in 2023 to $283 billion in 2028. SMCI is well-positioned to capitalize on the demand. As a pure-play AI server provider, it enjoys superior server offerings, strategic production capacity, and economies of scale (see the next slide below). In particular, I think the company's investment in direct liquid cooling (DLC) will be rewarded handsomely in the next ~2 years or so. I expect its DLC products to enhance data center efficiency, reduce data center cooling costs, and also save space substantially. Management expects the DLC technology to increase its market share from less than 1% to 15% within a year and I think the company is making good progress toward this ambitious goal judging by its Q4 ER. As a highlight, the company reported the delivery of its 8U liquid-cooled clusters for Nvidia's (NVDA) H100 AI chips (the first one to market). Other risks and final thoughts The price corrections after the Q4 ER represent a market overreaction in my view and have brought the stocks' valuation to an attractive level. More specifically, the chart below shows the FWD P/E ratios based on consensus EPS estimates for SMCI stock in the upcoming years. The forward P/E ratio is estimated at 15.83 based on its FY 2025 EPS, already a very reasonable level in absolute terms or relative terms. Its EPS is projected to experience substantial growth in the coming years, with YoY ranging from 54% to 21% in the next 3 years. The figure is then projected to decrease rapidly to 12.19 in FY 2026 and further to 10 only for FY 2027 thanks to the rapid growth forecast. With a current FWD P/E of 15.8x, the PEG ratio (P/E growth ratio) is far below the 1x PEG many GARP investors consider as the gold standard. SMCI's Board of Directors also authorized a 10-for-1 forward split of its common shares (with trading to commence on the split-adjusted basis in October), another sign of confidence in the stock's price appreciation potential. In terms of downside risks, SMCI and its peers in the AI sector face intense competition. The AI landscape is characterized by fierce competition, both among established tech giants and also new entrants. Besides this generic risk, a few risks are more pronounced for SMCI. Compared to many other more established AI players, SMCI's revenue streams are less diversified and rely heavily on the data center market, creating concentration risks. Another issue is cost control. The slide below shows the operating expenses and operating margin for SMCI stock. As seen, its operating expenses have increased rapidly in recent quarters, from about ~$130 million a year ago (in Q1 FY24) to $184 million in Q4 FY24. Due to this increase, its operating margins have been pressured to the current level of 7.8%. As the company grows, it will need to continue investing in talent, research, and development. It is important that the company can do so while keeping costs in control. All told, my conclusion is that the upside potential far outweighs the downside risks under current conditions. For investors who can look past the quarterly fluctuations and temporary setbacks, I see an excellent GARP opportunity with a PEG ratio substantially below 1x. I anticipate strong demand for its products (especially the liquid-cooled racks) in the upcoming years, judging by the record-low inventory data in recent quarters. As you can tell, our core style is to provide actionable and unambiguous ideas from our independent research. If you share this investment style, check out Envision Early Retirement. It provides at least 1x in-depth articles per week on such ideas. We have helped our members not only to beat the S&P 500 but also avoid heavy drawdowns despite the extreme volatilities in BOTH the equity AND bond market. Join for a 100% Risk-Free trial and see if our proven method can help you too. Envision Research, aka Lucas Ma, has over 15+ years of investment experience and holds a Masters with in Quantitative Investment and a PhD in Mechanical Engineering with a focus on renewable energy, both from Stanford University. He also has 30+ years of hands-on experience in high-tech R&D and consulting, housing sector, credit sector, and actual portfolio management. He leads the investing group Envision Early Retirement along with Sensor Unlimited where they offer proven solutions to generate both high income and high growth with isolated risks through dynamic asset allocation. Features include: two model portfolios - one for short-term survival/withdrawal and one for aggressive long-term growth, direct access via chat to discuss ideas, monthly updates on all holdings, tax discussions, and ticker critiques by request. Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. 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