The semiconductor industry was hit hard in the first half of 2022. According to the measurements of iShares Semiconductor ETF (SOXX -0.78%)chip stocks are down an average of 35% so far this year, compared with a negative return of 27% for Nasdaq Composite index.
Investors worry that the US Federal Reserve’s interest rate hike could send the economy into recession. Although the global chip shortage still keeps many semiconductor companies in growth mode, consumer spending on electronics is already falling — and some fear that business spending on chips may be next, and that this could start happening as early as 2023 Mr.
Whether or not there will be a major slowdown, chip stocks are priced in a cyclical decline anyway. Even top growth stories Advanced micro devices (AMD -1.54%) and Marvell Technology Group (MRVL -0.71%) were hit. Both are busy integrating transformational acquisitions right now. But given the long-term technology trends driving these businesses upward, they could be value right now. Is one of them a better buy?
AMD: Catapulting into new market opportunities
AMD is perhaps the biggest semiconductor stock story of the past decade. The company made drastic changes to its business model in the wake of the 2008-09 financial crisis, and its sharp focus on chip design and research has helped boost the stock’s 1,460% return over the past 10 years, even when factoring in 46 % price drop so far in 2022
AMD has been selling off recently due to the aforementioned consumer electronics slowdown. In the first quarter of 2022, about half of the revenue will come from consumer devices. However, cloud computing and AI applications for business are (and have been) the main growth driver here for the past few years. AMD’s enterprise segment grew 88% year over year last quarter thanks to its EPYC processors for data centers.
Midway through the first quarter, however, AMD completed its megamerger with industrial chip designer Xilinx. Besides adding a highly profitable competitor to its own operations, Xilinx brings a bunch of new markets to the table for AMD — including access to the automotive, industrial equipment, and aerospace and defense industries. Xilinx did just over $1 billion in sales in the first quarter, so it will be a huge contributor to AMD’s sales. Shortly after Xilinx, AMD also announced it was buying cloud networking startup Pensando for $1.9 billion in cash.
In early June, the chip designer raised $1 billion in fresh cash through a long-term debt offering. When you add that to its totals at the end of the last quarter, AMD will have $7.5 billion in cash and short-term investments, offset by $2.8 billion in debt. The stock trades for 30 times trailing 12-month free cash flow. If the new AMD can use its arsenal of cloud computing and industrial chips to maintain its momentum (expected full-year 2022 growth of 31% pre-Xilinx acquisition, 61% with Xilinx), it could be fantastic long-term value in the moment.
Marvell: A complete suite of big data solutions
Shares of Marvell Technology Group have also taken a big hit this year on concerns about a cyclical downturn, although that company’s end markets have little to do with consumer spending these days. In Q1, only 12% of sales went to consumer electronics. Marvell derives most of its revenue from data centers, 5G mobile network infrastructure and other telecommunications deployments, as well as industrial and automotive equipment.
Although consumers are hitting the brakes, Marvell’s end-market business spending is in high demand right now. Cloud computing and AI, 5G mobile networks and self-driving cars require the frequent movement of increasingly large amounts of digital data. Marvell is a leading supplier of DPUs (data processing units) that help with this task, and has a complementary portfolio of network and photonic circuits that it cross-sells with its DPU bread and butter.
Marvell also rose to this top position through acquisitions. However, unlike AMD’s giant merger with Xilinx, Marvell has been bringing together smaller chip designers for years. In 2018 and 2019, it bought three small sets focused on application-specific processors. And in 2021, it bought Inphi and Innovium to bolster its portfolio of optical networking and data switching components.
After the series of acquisitions, Marvell’s balance sheet is not so clean and tidy. Cash and equivalents were $465 million at the end of April and total debt was $4.5 billion. However, this should be tempered over time as Marvell is a highly profitable chip designer that generates plenty of free cash flow. The bottom line has been weak over the past year as the company digests its purchases, but profits are quickly recovering. The stock currently trades for 46 times trailing 12-month free cash flow, and management thinks earnings will continue to grow at a double-digit percentage rate through the end of this year.
Which semiconductor commodity is a better buy?
AMD and Marvell are the best chip stocks in my book. Both are following multiple secular growth trends and both have improved profit margins as well as successfully integrated recent acquisitions. Full disclosure – I own both stocks.
At this point, though, I believe AMD is a slightly more compelling buy. It has net cash on its balance sheet and is already generating a lot of profit. Marvell has a little more work to do in that department, so it might be a little more volatile than AMD stock. Still, if you’re looking for chip stocks that are rapidly changing with current technology trends, both companies have great potential over the next few years.
Nicholas Rossolillo and his clients have positions in Advanced Micro Devices and Marvell Technology Group. The Motley Fool has positions and recommends Advanced Micro Devices. The Motley Fool recommends Marvell Technology Group. The Motley Fool has a disclosure policy.