Stories about the impact of constrained supply chains on the global economy are rife these days, however NXP Semiconductors (NASDAQ: NXPI) The stock is approaching its all-time highs again after the earnings update for the third quarter of 2021. Revenue grew 26% year over year to $ 2.9 billion and adjusted operating income increased 64% to $ 959 million.
Supply chain issues are a particularly big impact on the automotive industry, which accounted for about half of NXP’s revenue last quarter. Nonetheless, NXP has grown because it beat the low results from the same period last year and also because the proportion of electronic components used in the refinement of a vehicle has increased dramatically. The supply chain constraints are expected to last through 2022 and possibly 2023, but this semiconductor designer and manufacturer could continue to expand at a healthy pace despite its troubles.
A study of supply chains in the automotive industry
Supply chain issues is the hot topic this reporting season and NXP was no exception. CEO Kurt Sievers spoke in detail about how chip supply bottlenecks had affected the company on the Q3 earnings conference call and highlighted the complex processes that the automotive industry uses to source parts. According to Sievers:
This extended supply chain must coordinate the timing and delivery of up to 30,000 parts and up to 1,500 different semiconductors from hundreds of suppliers to build just one car. In normal periods of time, from the dispatch of the finished component by NXP to the installation of the final assembly in a finished car, it can take up to six months, in addition to the cycle times of semiconductor production of three to six months.
However, this is not a “normal period”. After global auto sales declined in 2019 and 2020, the pandemic exacerbated electronics supply bottlenecks that emerged as a result of the U.S.-China trade war in 2018, and the booming sales mean it’s just not enough right now Chips there. NXP exited the third quarter with just 1.6 months of delivery time, about 30 days of delivery below the 2.5 month target that the company is sticking to. In other words, NXP can’t make chips fast enough for its automaker customers.
Now combine this shortage of supply with fundamental changes in the manufacture of a vehicle – namely electric drive trains, premium infotainment systems, vehicle connectivity, driver assistance systems, etc. Let’s take just one of these systems: electrification. An electric vehicle drastically reduces the amount of conventional parts in a car. In simple terms, a battery pack and motor replace a patchwork of systems such as the internal combustion engine, cooling system, fuel system, etc. However, while the need for traditional moving parts is being greatly reduced, semiconductors are increasing in modern cars and trucks.
Sievers said a typical hybrid or electric car needs about $ 900 worth of chips, twice as much as an internal combustion engine. Also, hybrid and electric vehicles have increased from around 8% of global production in 2019 to around 20% this year. And that even before we talk about how driver assistance systems and vehicle autonomy affect cars. Get an idea? Supply chains are strained by incredibly rapid changes in the way cars are made.
The good news, at least for NXP
Given that half of its sales come from the automotive sector, NXP is an interesting proxy for the current shortage of spare parts. For now, demand exceeding production means NXP’s sales will pick up again in the fourth quarter (at an expected rate of 17% to 23% year over year). But extended lead times on orders (well over a year in many cases) mean the company could continue to grow in 2022 and beyond. In order to keep pace with future demand as more and more vehicle production facilities switch to hybrid and electric vehicles, NXP is investing in new manufacturing capacities with long-term purchase commitments from its customers.
It is important to remember that chip manufacturing, like all manufacturing, is cyclical in nature. At some point the imbalance between supply and demand will normalize and NXP’s growth trajectory will cool – or even temporarily shrink. However, given the tremendous importance of semiconductors for automobiles and for NXP’s other end markets such as industrial equipment and communications infrastructure, this is likely to remain a growth story in the long run. Just expect some ups and downs along the way.
After the Q3 update, NXP stock will trade at 24 times the 12-month free cash flow at company value. This isn’t a cheap semiconductor designer and factory right now, but it may be of long-term value if you plan to buy and hold during the extensive development of the auto industry over the next decade and beyond.
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