The semiconductor industry as a whole may be entering a cyclical downturn - Bank of America analysts warned in a note Wednesday. We think this note is largely responsible for today's slide in portfolio holding Advanced Micro Devices (AMD) particularly and the semiconductor group in general. However, beneath the surface, BofA see opportunities to be had: they are keeping a buy rating on AMD (which we own) and Nvidia (which some of our clients own).

Big picture

Semiconductors have historically been a cyclical industry, seeing sales slowdowns every few years that appear to be related to the pace of global GDP growth. Now, of course, there’s all sorts of concerns about global growth, and Bank of America believes chip sales will take a hit this time, too.

The analysts, Vivek Arya and Blake Friedman, now project global semi sales of $608 billion in 2022, representing a 9.5% year over year increase. Previously, they expected revenue to increase 13% compared with 2021. For 2023, they expect total semi sales of $604 billion, down 1% compared with their 2022 forecast. Their old projections called for sales to increase 7% in 2023.

Despite these topline revisions, Arya and Friedman see some factors providing relative support for chips. “Tighter global monetary policy, geopolitical turmoil and consumer weakness is likely to pressure 2HCY22/CY23E chip demand. However, unit weakness could be cushioned by richer non-consumer mix, robust pricing, expanding content, and constrained supply,” they write. (Note: 2HCY22/CY23E stands for second half of calendar year 2022 and estimates for calendar year 2023.)

The details

Yes, the analysts cut their price targets on the semis as they lowered earnings and sales outlooks for 2022 and 2023. But since the stocks have dropped so much in the recent market turmoil, the new price targets actually represent significant upside compared to Tuesday’s close. Thus, the Bank of America analysts continue to rate each of them as buys.

• AMD: $110 per share, down from $160. Roughly 36% upside.

• Nvidia price target: $220 per share, down from $270. Roughly 37% upside from prior close.

We’re not necessarily comforted by the specifics of those price targets, but rather the reasons supporting BofA’s belief that the stocks can be bought here. One of those reasons is that these two names particularly have large exposure to cloud computing and artificial intelligence, which the analysts consider one of their favorite structural themes. In general, the analysts believe that non-consumer sales of non-memory chips will hold up better than consumer end markets, which include personal computers, smartphones and gaming graphics processing units (GPUs).

• As a reminder, the growth of data center market is a major contributor to our favorable view on AMD.

• AMD does have PC exposure, but the company has recently focused its efforts more on the higher-performance computers that corporations and gamers buy instead of lower-end consumer products, where demand is believed to be softer.

• We recognize AMD and Nvidia both sell gaming GPUs and that part of their business could slow compared to the strong growth its seen during the pandemic. But, as noted above, we think data center should be resilient, and the secular shift to the cloud also remains intact.

Another key reason Bank of America sees them as worth buying here is related to the idea that stocks are forward-looking assets. Chip stocks have already been crushed this year, in part, because many investors think an economic slowdown is on the horizon. As a result, they have recalibrated their expectations for future earnings and what they’re willing to pay for them, leading to the valuations of semi stocks to compress.

The PHLX Semiconductor Sector Index, known as the SOX, has seen its forward earnings multiple fall considerably since late last year. According to BofA, the SOX’s forward PE has fallen about 42% from its cycle peak, compared to an average decline of 26% in the past four downturns. This, the analysts write, suggests “valuations may bottom shortly.” “For instance semi sales were fine in CY18 but the SOX declined, anticipating the CY19 downturn. The Sox index however surged 60% in CY19 despite weaker sales since most of the selling had already taken place in CY18,” the analysts also write. (Again, note that CY18 means calendar year 2018.)

Bottom line

Is this note a surprise? No. Morgan Stanley analyst wrote a note on AMD last week (which we covered here), they didn't slash AMD price target but the underlying themes of these notes were similar: i) AMD is strong because of data center and ii) the semis have gotten so bad that it's good.

We remain buyers of AMD, as we have been since the $100 price level. Since we reported our thoughts in May when AMD was trading in the $100 price level, there has been no fundamental deterioration in AMD as a company. If an argument is to be made, the fundamental actually has gotten better after their analyst day earlier this month. After a 20% decline, we believe this is a strong buy.