STMicroelectronics RECENT UPDATES
• At end of Q4 2020, STMicroelectronics and the company Advantest Corporation announced to investors that they built together an automated and technologically advanced final-test cell system that increased significantly the efficiency and the quality of several business equipment such as semiconductor test and packaging operations.
• In December 2020, STMicroelectronics and the firm LeddarTech started to work together for the creation, development and sale of LiDAR solutions.
BUSINESS MODEL & STRATEGY
STMicroelectronics was created and incorporated in 1987 as a result of the business combination between the Italian SGS Microelettronica and Thomson Semiconducteurs. From a business perspective, STMicroelectronics is an Italian-French company specialized into the production and the sale of semiconductor electronic components: indeed, it designs, manufactures and sells a wide-range of products, including standard and customized semiconductor components, application-specific integrated circuits (ASICs), full-custom devices and semi-custom devices and application-specific standard products (ASSPs) for analog, digital and mixedsignal applications.
Specifically, its products can be classified into three different segments and product categories: - Automotive and Discrete Group (ADG), included dedicated automotive ICs (both digital and analog), and discrete and power transistor products; - Analog, MEMS and Sensors Group (AMS), for instance low-power high-end analog ICs smart power products for Industrial, Computer and personal electronics markets, Touch Screen Controllers, Low Power Connectivity solutions (wireline and wireless) for IoT, power conversion products, metering solutions for Smart Grid (e.g. imaging sensors) and all MEMS products for sensors or Actuators; - Microcontrollers and Digital ICs Group (MDG), such as general purpose and secure microcontrollers, EEPROM memories, Digital ASICs, Aerospace and Defense products.
STMicroelectronics provides its products and services to around 100,000 customers across a range of markets, such as automotive, industrial, personal electronics, and communications equipment, computers and peripherals. Among its top 10 corporate clients, it is possible to distinguish: Apple, Bosch, Continental, HP, Huawei, Tesla, Nintendo, Samsung, Seagate. Almost 70% of its revenue are coming from Apple. This strong dependency on Apple implies a low bargaining power and high risks and threats for ST, especially if Apple implements vertical integration strategies for the production of the components. Specifically, it has three regional sales organizations reporting to a worldwide head of sales & marketing: Americas, Asia Pacific, Europe, Middle East and Africa Region. Over the past 5 years, the most profitable geographic regions are represented by the following countries: Netherlands, France, Italy, USA, Singapore and Japan. It engages distributors and sales representatives to distribute and promote its products worldwide. The firm’s revenues, expressed in millions, are $ 9,556 in 2019 split over the several segments; Analog, MEMS & Sensor Group represent the category with the highest growth. Its revenue CAGRs are -1,1% (2019), +15,8% (2018), +19,7% (2017), while the global semiconductor industry revenue growth are: -12,0% (2019), +13.7% (2018), 21,6% (2017). According to Statista, its market share within the semiconductor industry worldwide amounts to 2.3% in 2019, that is far below the level of 4% in the 2008.
Among the company’s strengths, it is necessary to mention as follows: strong distribution network; huge distributors and dealers’ community; reliable suppliers of raw material that enables the company to overcome any supply chain bottlenecks; highly skilled employees since the firm invests a lot of resources in training and learning programs for its workforce; high liquidity ratios and cash flows to be invested in profitable projects. Concerning its value chain, the company acquires raw materials, gas, chemicals, energy and services from many suppliers and subcontractors such as for instance ARROW Electronic Components and Avnet.
Even though STMicroelectronics seems very well solid for the long-term, it has many weaknesses and threats. Firstly, the industry is characterized by an intense competition, due to the huge number of players in the industry (e.g. Microchip Technology Inc, Marvell Technology Group Ltd, Xilinx Inc) that put downward pressure on profitability. Raw materials and components are characterized by high price volatility. Then, the level of investments in R&D is below the fastest growing players in the industry, even though the company is spending above the industry average. Additionally, the firm is not often able tackle the challenges present by the new entrants in the segment, indeed it has lost small market share in the niche categories.
Indeed, there are gaps in the product range sold by the company. Besides, since the company operates worldwide, it is subject to different country laws and it may be exposed to various liability claims given change in policies in those markets. For these reasons, ST’s riskiness is reflected in a high market beta (i.e. 1.51), implying that the company overreacts the market.
OWNERSHIP
As of December 2019, the firm’s ownership includes:
- STMicroelectronics Holding NV (27.50%), registered in Netherlands and owned by the Italian Ministry of the Economy and Finance (MEF), the French Bpifrance and the French Alternative Energies and Atomic Energy Commission (CEA);
- Public Investors (70,30%), since STMicroelectronics stocks are listed on Euronext Paris, New York Stock Exchange and the Borsa Italiana in Milan;
- Treasury stock (2,20%).
MANAGEMENT & ESG ANALYSIS
Sustainability is one of the most significant pillars of the company’s management value proposition. It is embedded in the firm’s DNA and into the daily activities of its 46,000 employees. The management objective is to approach sustainability by identifying the opportunities and challenges associated with the long-term trends within the society: ST’s technologies are enablers of safer, greener mobility, advanced power & energy management across all types of systems and devices, and at the heart of the IoT & 5G.
Environment: the manufacturing of semiconductors requires a tremendous amount of raw materials (e.g. electricity, water, components, chemical treatments), thus some of the main environmental problems faced are related to pollution, GHG emissions, waste. STMicroelectronics declared that its products are conflict-mineral free, around 41% of water is recycled and reused, around 94% of waste is reused, recovered or recycled, around 62% of new products are classified as responsible products, -21% GHG emissions with respect to the values gained in 2016.
Social: the company culture is based on social and relationship values (e.g. sustainability, integrity, people and excellence), defined in the internal Code of Conduct. During 2019, the firm donated around US$1.8 million cash and more than 145,000 hours to local communities for helping social projects. There are in place around 389 education and volunteering initiatives from 33 sites worldwide.
Governance: STMicroelectronics’s corporate governance policies and practices are described in the following documentation: Corporate Governance Charter, Supervisory Board Charter and Managing Board & Executive Committee Charter.
MARKET ANALYSIS AND OUTLOOK
Technological progress has been made possible due to the development of semiconductors and its industry has outperformed the S&P 500 for several years. They are used to build PCs, tablets, laptops, smartphones and every kind of electronics that we use in our daily life. The industry is growing rapidly, which results on significant changes in society. The rising interest for Artificial Intelligences, The Internet of Things, Cloud Computing and Data Warehousing is one of the biggest demand drivers. The increase in the number smart factories is another signal of this growing trend. The adoption of automation enhanced with autonomous systems requires a high number of these technologies. At the moment the US is running a shortage of semiconductors and some car factories were forced to close temporarily as the high demand for electronics during the pandemic has increased the demand for them. The international labor organization has estimated an increase of 300 million people working from home and that there are now 1.3 billion student doing online learning thus putting an unprecedented upward pressure for the demand of electronics and semiconductors.
STMicroelectronics is a Dutch multinational company, producing electronics and semiconductors – materials that partially conducts current and is often used for electronic circuits. Global semiconductor sales have increased to $439 billion in 2020, a 6.5% yearly increase, despite the COVID19 pandemic and the trade war between US and China. Overall, the major semiconductor companies performed strongly in the last quarter of 2020. Qualcomm’s revenues increased by 32% in the 4th quarter, NXP and AMD semiconductors by more than 10%, and Texas Instruments, Infineon and Intel by almost 10% while STMicroelectronics’ decreased by 3.5%. The global market for electronics is valued around one and a half trillion US$. In the last decade, it has increasing at an average compound rate higher than 5%. This growth is driven by an augmenting demand in Asian countries, in particular by middle classes that are starting to invest in electronic products.
The key market drivers for semiconductors are the industries for which these materials are used, we can see them on the graph at the right: smartphones, PCs and light vehicles such as automobiles and small trucks. Gartner is expecting an 11% growth in smartphone production as production returns to its normal level after the delays caused by the pandemic. The increasing popularity of 5G new phone models are another element that will increase demand for semiconductors. Demand for PCs has increased by 11% in 2020 as they are a necessity for remote working and learning. This number is expected to decrease to its normal level of 1% growth in 2021. Light vehicle production was strongly hit by the pandemic and the demand dropped by 17% during the last year. However, IHS Markit forecasts a 14% increase in production for this year. Even if the automotive industry composes only 10% of demand, its relevance is going to increase due to the higher demand for electric vehicles and Advanced Driver Assistance System.
Competition and Market Share
The semiconductor market shares for 2019 can be seen on the graph on the right. The market is fragmented between different suppliers. The leading biggest player is Intel with around 16% of the market share in 2019, followed by Samsung with 12.5%, SK Hynix with 5.4%, Micron Technology with 4.8%, Broadcom with 3.7%, Qualcomm with 3.2%, Texas Instruments with 3.2%, STMicroelectronics with 2.2%, Kioxia (Toshiba Memory) with 2.1%. China is the world’s largest importer of semiconductors according to the semiconductor industry association. Due to the US ban on selling chips and chipmaking technology to China, Tianyancha, a corporate registration tracker, stated that more than 50,000 Chinese businesses related to semiconductors registered this year, 300% more than the previous years. Competition from China could take a lot of market shares away from western companies.
Traditional customers and partners are now implementing vertical integration strategy as they are not willing anymore to rely on external suppliers. There are also some new producers that are entering the market, and this is going to have a great impact on semiconductors producers. Semiconductor companies are not only competing with each other but also with their own costumers. Big tech companies such as Apple, Amazon, Cisco, and Tesla, some of the biggest consumers of chips worldwide, are also entering the market with organic growth strategies by producing their own chips. If these strategies are followed by other companies, the trend is going to have a drastic impact for companies like STMicroelectronics.
Competitive landscape
Infineon Technologies AG
Net Revenue: 8,567 Million $US
Operating Income: 581 Million $US
Net Income Before Taxes: 424 Million $US
Growth Revenue: 6.7%
Net Margin: 4.3%
Operating Margin: 7.7%
ROIC: 2.5%
Market Capitalization: 47,796.71 Million $US
NXP Semiconductors N.V
Net Revenue: 8,612 Million $US
Operating Income: 358 Million $US
Net Income Before Taxes: 1 Million $US
Growth Revenue: -3.0%
Net Margin: 1.0%
Operating Margin: 4.2%
ROIC: 0.5%
Market Capitalization: 53,597.22 Million $US
Advanced Micro Devices Inc
Net Revenue: 9,763 Million $US
Operating Income: 1,315 Million $US
Net Income Before Taxes: 1,275 Million $US
Growth Revenue: 45.0%
Net Margin: 25.5%
Operating Margin: 13.5%
ROIC: 48.7%
Market Capitalization: 107,738.91 Million $US
Pandemic Effect
Semiconductor companies are vulnerable to supply chain risks. After COVID-19 started to spread, semiconductor companies implemented safety measure to protect their employees, their supply chain and address other issues caused by the virus. Every part of their strategic plans may be subject to change. Technical changes had to be implemented to better protect employees. Supply chain and manufacturing changes have to be done in order to have a more stable and reliable value chain since the virus is causing many delays in the chain of production. Without the appropriate changes there could be a shortage of components that are present within the company but cannot be moved to the right places. This impact is not noticeable for the moment but it will hit in the longer term with the new generations of product. Companies should organize contingencies plan in order to manage disruptions as global supply chains are too fragile. Manufacturers and suppliers have to collaborate more to establish more agile supply networks.
FINANCIAL ANALYSIS AND ESTIMATES
• STM’s sales have decreased in 2019 due to a 12% consequent decline in TAM – cyclicity of the semiconductor industry – but show strong resilience during the pandemic (+6.9% expected). Operating margins remain relatively stable, as a result of price pressure and unsaturation charges offset by manufacturing efficiencies, better product mix and favourable forex effects.
• The company has a positive and increasing operating cash-flow generation due to the fact that sales growth is lower than the increase in operating expenses and investment in net working capital. Investments in capital expenditures are stable and offset D&A in PPE. Positive FCF allows the company to pay yearly dividends to shareholders (~$215mn).
• The firm’s capital structure is very healthy, providing strong guarantees for the repayment of its debt obligations. Regarding the asset side, STM owns consequent reserves of cash ($2.6bn), driving to a negative indebtedness – long term debt is worth $1.2bn. Non-current assets are mainly advanced manufacturing facilities owned by the company, whose useful life is estimated to be ten years, hence the non-negligible D&A charges. All things being considered, we are not worried about potential solvency or liquidity issues from STMicroelectronics.
VALUATION
• Our 12-month €37.17 price target is based on a 50:50 DCF:Comps. €25.2/shr (DCF based on discount rate 11.3%, terminal growth 2%). €49.2/shr from Comps.
• DCF valuation leads to a target share price of €25.2 (using the perpetuity growth method for the terminal value, a discount rate equal to STMicroelectronics’ WACC of 11,3%). We assumed an averaged 5% yearly growth for revenues from 2026 and a constant EBITDA margin of 25% (knowing that STMicroelectronics current EBITDA margin is 21,7%). Projections for net capex are computed as a percentage of sales of about 11%.
• Comparable analysis was based on four companies: Infineon Technologies AG, NXP Semiconductors N.V, Advanced Micro Devices Inc and Microchip Technology Incorporated. Those four companies are similar on various points with STM: present in the European, the Asian and the American markets and sell the same type of products. Even if SMT’s market capitalization is below the others, they have comparable size in terms of revenue and EBITDA. STM appeared largely undervalued with an EV/EBITDA of 16.9x compared to a median of 24.1x for the comparable companies. Applying this 24.1x ratio with the EBITDA of STM, the implied share price is worth €49.18.
INVESTMENT THESIS
• We set a hold recommendation for STMicroelectronic’s stock, with a 12-month target price of €37.17 vs €32.90 currently, representing a 13% premium.
• We are strongly bullish on the semi-conductor market’s growth potential due to numerous applications in various promising industries that will sustainably drive the demand for semi-conductorbased items.
• STM is particularly well diversified in terms of geographics – addressing dynamic markets – and activities, and its growth strategy is supported by the quality and experience of the top management.
• Financials are healthy with stable growth (~8% CAGR taking into account industry cycles) and margins, and riskless capital structure.
• The dutch company is likely to suffer the vertical integration from large existing clients (Apple representing 17% of STM revenues) and accrued dependency could lead to losses in market share.
• The high number of incumbents globally – especially in the US –, more or less specialized, as well as the intensity of competition in a very fragmented market undermines and threatens STM’s current market share. Compared to other competitors, we did not identify a sustainable competitive advantage that will make us think that STM is armed enough to outperform the market. That is a reason why the market is “undervaluing” the company compared to its peers