Semis have outperformed Tech in 2019 after a strong correction at the end of last year. The Semis ETF (SMH) is up 19% YTD vs. 12% for Nasdaq (QQQ) and S&P 500 (SPY). Oddly, the Semis outperformance YTD is despite weak fundamentals in the sector. Goldman for example noted in their recent report on the sector:

Our recent industry discussions suggest that memory fundamentals remain very soft, and prices continue to decline. This is in contrast to the significant rally in the memory and HDD stocks year to date even on weak fundamentals”.

Semis vs. Tech were oversold into year-end 2018, and bounced back

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The sustainability of this rally can be interpreted through two lenses.  The bear case is that this bounce is temporary and Semis have further to fall if fundamental weakness persists. The bull case is that fundamentals are close to bottoming and will improve shortly. In this scenario, stock prices have rallied in anticipation of better fundamentals, which typically occurs during market bottoms.

Which one of these scenarios turns out to be correct is impossible to predict.  The onus of proof is on the bull case. On a company level, Micron (MU) and Nvidia (NVDA), two of the biggest players in the industry are seeing negative EPS revisions and a steep decline in EBITDA margins YTD, reflecting weakening industry fundamentals.

Earnings revisions are negative for MU and NVDA

4 resilient “winners” in the current Semis environment

Despite the soft fundamentals in the sector, 4 companies are bucking the weakening semi trend with strong stock performance YTD: XLNX, AMD, ADI, CDNS. These stocks are showing bullish relative strength (vs. SMH) and are worth calling out.

4 “winners” have outperformed the Semis ETF

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EBITDA margins for the “winners” have remained resilient, others have declined

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In  addition, the EBITDA margins of these stocks has help up better vs, others. The companies have not seen margins compress as was the case for industry leading names like MU and NVDA.   

Below is the bull case for these companies and their business lines.

Xilinx (XLNX, $31B)

  • Victor Pent took over as Xilinx CEO in 2019 and realigned the company’s exposure to the fastest growing end-markets like data centers and autonomous vehicles.
  • XLNX is positioned to take market share away from other companies like Intel.  
  • Microsoft started using XLNX chips in its Azule servers last fall at the expense of Intel. Other cloud providers are also switching to chips made by XLNX because of their flexibility and low latency.  These market share gains have helped XLNX offset the industry-wide downturn and recent macro weakness.
  • Goldman moves Xilinx from Conviction Buy to Buy, but raises price target from $105 to $122 (Feb 4)

XLNX has recently outperformed INTC even through the two were correlated historically

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Cadence (CDNS, $16B)

  • Cadence focuses on Electric Design Automation (EDA) that enables electronic systems and semiconductor companies to create products faster and more efficiently.
  • Cadence reported earnings on Feb 19 and beat consensus estimates by $0.05.  2019 EPS was revised up 4% by analysts from $1.96 to $2.03.
  • The company has a forward P/E of 28x because investors value it more like a software company vs. a traditional semiconductor company

Advanced Micro Devices (AMD, $24B)

  • Despite EBITDA margin decline similar to MU and NVDA (see chart), stock has performed well YTD 2019
  • Either investors are looking past the decreased margin, or stock price will catch up to fundamentals
  • Stock reaction to weakness in 4Q18 earnings was more positive than expected (link)
  • AMD estimate revisions look much more healthy vs. other SMH components
  • AMD is taking market share from underperforming rivals NVDA and INTC
    • AMD outpacing Intel sales (link)
    • AMD CEO Lisa Su explicit that taking significant market from Intel a central goal in 2019
    • In Oct. 2018, AMD had 65% of desktop CPU market in some channels because of problems at INTC (link).
    • Moving forward in 2019, AMD will implement first-in-kind manufacturing process for growing CPU and GPU markets (link)

Analog Devices (ADI, $39B)

  • From the end of 2Q18 to their respectives lows in 4Q18, both ADI and the broader SMH lost about 20% of their value
  • Since then, Analog Devices beat estimates for the first time in 4Q18 on strong communication chip performance (link)
    • Impacted by industry-wide sales slowdown, earnings and sales were both lower Y/Y despite earnings beat
    • CEO Vincent Roche cited 4G upgrades and 5G initial deployments as helping drive communication sales
    • ADI has outperformed the broader SMH by 20% over the past year (see chart)
    • Analog has a strong history of increasing dividends (16 times in 15 years), most recently increasing its quarterly dividend 12.5% to $0.54/share

ADI outperformed in the Semis uptrend and downtrend

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Further evidence is needed to determine whether the sector has turned. In the mean time, investor should focus on these 4 Semis companies because of their relative fundamental and technical strength.  These stocks offer an attractive defense while the sector finds its footing.