On August 9, 2022, the Creating Helpful Incentives to Produce Semiconductors for America Act (“CHIPS Act” or the “Act”) was signed into legislation. This legislation could provide a very large long-term catalyst of growth for semiconductor stocks, as the U.S. government will provide billions in stimulus to support semiconductor producers, which should both improve growth prospects for these companies and shore up their balance sheets.
According to the official summary, the CHIPS Act “authorizes the Department of Commerce (DOC), Department of Defense (DoD), and Department of State (DOS) activities to develop onshore domestic manufacturing of semiconductors critical to U.S. competitiveness and national security.”
Touted as the most significant investment in industrial policy the U.S. has made in 50 years, the CHIPS Act, represents a massive bid to breathe life back into the tech-focused sectors of the American economy while reorienting the future of advanced technology manufacturing domestically, against the backdrop of a decades-long rivalry with China.
With more than $54 billion in promised spending over 5 years, there is the potential for significant economic expansion within the semiconductor and technological manufacturing sectors in North America.
For investors interested in the semiconductor sector, now could be a beneficial period to consider gaining exposure, given that this is still the “early days” of reshoring and rebuilding the domestic tech industry. Currently, valuations may not reflect the full potential of the opportunity. Let’s take a look at how and why Canadian investors should consider incorporating semiconductor exposure into their portfolios.
Semiconductor Primer + Story
Semiconductors are one of the single most important components in the development of emerging and modern technologies. As an essential component of electronic devices, semiconductors allow and moderate electrical current to power devices and are typically silicon or germanium-based.
They are the core components of microprocessor chips as well as transistors, which in turn, are the key technologies associated with anything that’s computerized or uses radio waves, including electric vehicles, robotics, medical technology, electronic appliances, and more.
The industry is comprised of three development stages: design, fabrication, and assembly. Integrated device manufacturer companies (IDMs), such as Intel Corporation and Samsung, provide an umbrella service where all stages of development are performed in-house. Alternately, fabless companies only manage microchip design but contract out their production. Before the first silicon transistor was built in the US in 1947, most electronics ran on vacuum tubes, which were large and inefficient. While semiconductors have been around for more than 75 years, they became a household topic in 2020 due to the impacts of COVID-19 on global supply chains, affecting semiconductor manufacturing and delivery wait times.
The Wait for Chips
Lead times for semiconductors fell by one day in June
Source: Susquehanna Financial Group
Rebounding demand after the initial shock of the pandemic, coupled with ongoing semiconductor supply chain disruptions, has resulted in significant wait time increases for semiconductors. Consequently, reduced manufacturing and delivery of many electronics, cars, and other semiconductor-reliant devices are continuing to cause economic disruptions. Since 2017, wait times for semiconductor delivery have more than doubled from 12 weeks, with an average wait time now of 26.9 weeks, as at July 2022.
Despite the delivery slowdowns, business is booming. In 2021, 1.15 trillion semiconductors were sold for a total of $555.9 billion in sales – the highest ever annual total and an increase of 26.2%, compared to 2020.
Much of that sales volume has been driven by one semiconductor manufacturer in particular: Taiwan Semiconductor Manufacturing Corporation, the world’s first pure-play semiconductor foundry. Alone, it accounts for 53% of the market share of the semiconductor foundry market. As a whole, Taiwan-based companies control 63% of the market.
Source: The Whitehouse, Building Resilient Supply Chains, Revitalizing American Manufacturing, and Fostering Broad-Based Growth, as at June 2021
It’s worth noting, however, that the United States still maintains dominance in the research and development of advanced microchips. While Taiwan is crucial in the supply chain on the manufacturing, a large proportion of the intellectual property associated with the more advanced microchips remains firmly under U.S. control. The CHIPS Act would seek to effectively ensure that a significant portion of manufacturing alongside research and development occurs in the United States.
Meanwhile, American-based manufacturing has dwindled from 37% in the 1990s to only 12% in the present day. Government-funded manufacturing and subsidization, coupled with off-shoring have resulted in growing Asian dominance in the semiconductor sector.
However, with the capital injection from the CHIPS Act, it is expected that 10 to 15 new semiconductor factories in the U.S. will be funded, assisting the U.S. in rebuilding its position in the global industry. While some level of semiconductor shortage could be alleviated by the re-shoring, it will likely take years for new manufacturing hubs to come online.
With that, there’s no guarantee that the semiconductor crisis will be alleviated anytime soon, which will continue to drive prices higher, due to strong demand and no supply. Although data from J.P. Morgan’s research suggests the shortage may be nearing an end, a mismatch of chips may continue to complicate the near-term picture, particularly with the rise of electric vehicles.
What’s Happening Right Now
In 2021, the global semiconductor market was valued at USD 527.88 billion. By 2029, that value is expected to nearly double to more than USD 1 trillion. Notwithstanding the impacts of supply chain disruptions and COVID-19-related complications, consumer demand for chip-based and advanced electronics has steadily increased. With no indication of slowing, semiconductor futures are currently experiencing robust market stimulation.
On August 1, 2022, the Semiconductor Industry Association reported that global sales in the second quarter (Q2) increased by 13.3% when compared to Q2 2021, totaling USD 152.5 billion. Although the quarter saw an overall decrease of 1.9% in sales, likely attributed to geopolitical uncertainty and bottlenecks in supply, tail-end growth shows a rebounding of 0.5% from Q1 2022.
Worldwide Semiconductor Revenues (Year-to-Year Percent Change)
Source: World Semiconductor trade statistics, as at June 30, 2022
Due to the initiated 25% tax credit for companies investing in domestic semiconductor manufacturing, there is overwhelming potential for investors to leverage long-term buy-in opportunities, as many semiconductor juggernauts move to stake a claim on multi-billion-dollar subsidies.
In reaction to the signing of the CHIPS Act, a nearly USD 50 billion in additional investments have been allotted to the development and manufacturing of semiconductor futures, the White House reported on August 9, 2022. To date, Micron Technology (MU), an American semiconductor manufacturing company, has announced a USD 40 billion investment in chip technology, poised to create 40,000 new jobs – this represents an 8% increase, from 2% to 10%, in the market share production — within the next 10 years for the U.S.
This follows American industry leader, Intel Corporation’s (INTC), commitment to developing a USD 20 billion semiconductor facility in Ohio that was dependent on the government enacting manufacturing subsidies. Further, Taiwan Semiconductor Manufacturing (TSMC) – which received government subsidization for a USD 12 billion plant in Arizona in 2020 — and Texas Instruments (TXN), are both certain to benefit.
Additionally, world-leading fabless semiconductor and software development company, Qualcomm (QCOM.O), and multinational semiconductor contract manufacturing and design company, GlobalFoundaries (GFS.O), announced a USD 4.2 billion expansion partnership dedicated to the manufacturing of semiconductors in GlobalFoundaries’ New York facility. The details of the partnership include a forecasted 50 percent increase in production over the next 5 years, expanding the company’s previous USD 3.2 billion agreement to develop semiconductors for 5G transceivers, Wi-Fi, automotive, and Internet of Things (IoT) connectivity.
What the Future for Semiconductors Looks Like
Presenting a compound annual growth rate (CAGR) of 7.4% over the next 7 years, as reported by Bloomberg in July 2022, the CHIPS Act is working to solidify the presence of the U.S. in pending growth through emerging technology markets, such as electric vehicles, nanotechnology, clean energy, quantum computing, and artificial intelligence, all reliant on semiconductors.
The business consulting firm, McKinsey and Company, reports that based on an estimated year-over-year growth of between six and eight percent, the semiconductor industry could actualize a value of USD 1 trillion by 2030. Presently, 70% of the future of the chips industry is heavily dependent on three key technology sub-industries: automotive, computation and data storage, and wireless industries.
It is predicted that the automotive industry will account for the majority of industry growth as vehicles become increasingly dependent on electric technologies. Advancing safety technology, self-operation, internal notification features, and fail-safe systems all depend on chips. In relation, the automotive industry is on track to account for 13 to 15 percent of chips demand by 2030. McKinsey estimates that this figure could drive as much as 20 percent of expansion over the next decade.
Another major driver of semiconductor growth and advancement is the International Energy Agency’s (IEA) policy push to see net zero emissions by 2050, which requires another 230 million electric vehicles to make their way to consumers by 2030. The IEA details that, to date, “more than 20 countries have announced the full phase-out of internal combustion engine (ICE) car sales over the next 10‑30 years, including emerging economies such as Cabo Verde, Costa Rica, and Sri Lanka. Moreover, more than 120 countries (accounting for around 85% of the global road vehicle fleet, excluding two/three-wheelers) have announced economy-wide net-zero emissions pledges that aim to reach net zero in the coming few decades.”
Computation and Data Storage
Once considered a science fiction fantasy, advancing computing technology, such as Artificial Intelligence (AI), has become integrated into everyday processes. The backbone of these technologies, semiconductors, are essential to basic AI development as they allow algorithms to store, run, and test data.
In June 2022, Nir Kaldero, Chief AI officer at NEORIS and Adjunct Executive for AI at CEMEX, reported that, among a number of different factors, the emergence of Web3 and the digital multiverse over the next decade will take center stage in AI-related semiconductor advancements. Moreover, artificial intelligence has found its way into research and development being conducted in numerous sectors including healthcare, education, media, and customer service.
In the near future, AI technology and cloud computing could drive the growth of four to six percent in the semiconductor market moved by the demands for new technology to support new applications.
At the helm of wireless advancement, this decade is the fifth generation of mobile networking, 5G. According to Silicon Semiconductor™, an Angel Business Communications publication, as the new global standard, 5G works to connect machines, objects, and devices to deliver expanded multi-Gbps peak data speeds, ultra-low latency, reliability, robust network capacity, and access.
Bolstered by 5G growth, smartphones are likely to provide significant contributions to semiconductor growth through this sub-sector as industry standards pivot to take advantage of lower to mid-tier segments in emerging markets.
Canada’s first global semiconductor ETF, Horizons Global Semiconductor Index ETF (CHPS; CHPS.U), provides diversified exposure to publicly listed companies involved in the production and development of semiconductors and semiconductors equipment.
The fund seeks to replicate, to the extent possible and net of expenses, the performance of the Solactive Capped Global Semiconductors Index, hedging the U.S. dollar value of its portfolio to the Canadian dollar at all times.
The Solactive Capped Global Semiconductors Index is a capped market capitalization index designed to provide exposure to the performance of global, publicly listed equity securities of companies that are involved in the development or production of semiconductors and semiconductor equipment.
Source: Bloomberg, as at August 22, 2022
Our view is that Canadian investors should consider global exposure to this sector. Currently, as at August 22, 2022, many of the larger Asian semiconductor producers are trading at a lower price-to-earnings multiple than large U.S. names such as NVIDIA and AMD, which we attribute to investors having some geographic concerns about East Asian producers in Taiwan. The CHIPS Act will seek to reorient the global supply chain system so that companies such as TSMC should benefit from some of the stimulus spendings as they move some production facilities to North America. For example, TSMC is building a $12 billion chip fabrication plant in Arizona.
For Canadians seeking exposure to the performance of leading semiconductor manufacturers, CHPS and CHPS.U are designed to deliver ideal exposure for investors who receive currency-hedged exposure and potential additional tax consequences of holding the U.S. listed ETFs in the sector.
|Top 10 Holdings as at July 31, 2022|
An American multinational technology company
|Taiwan Semiconductor Manufacturing Co Ltd – ADR
A Taiwanese multinational semiconductor contract manufacturing and design company
|ASML Holding NV
A Dutch multinational corporation specializing in the development and manufacturing of photolithography systems, used to produce computer chips.
An American designer, developer, manufacturer, and global supplier of a wide range of semiconductor and infrastructure software products.
An American multinational corporation that creates semiconductors, software, and services related to wireless technology.
|Texas Instruments Inc
An American technology company that designs and manufactures semiconductors and various integrated circuits, for electronics designers and manufacturers globally.
|Advanced Micro Devices Inc
An American multinational semiconductor company that develops computer processors and related technologies for business and consumer markets.
An American multinational corporation and technology company.
|Applied Materials Inc
An American corporation that supplies equipment, services and software for the manufacture of semiconductors.
|Analog Devices Inc
An American multinational semiconductor company specializing in data conversion, signal processing and power management technology.
Horizons ETFs Management (Canada) Inc.
Horizons ETFs Management (Canada) Inc. is an innovative financial services company and offers one of the largest suites of exchange traded funds in Canada. The Horizons ETFs product family includes a broadly diversified range of solutions for investors of all experience levels to meet their investment objectives in a variety of market conditions.
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