STMicroelectronics Is Significantly Undervalued With High Growth Potential (NYSE:STM)

There are many semiconductor companies to choose from, and many offer compelling valuations and future operational and financial advantages. However, at this time, STMicroelectronics N.V. (NYSE:STM) looks like one of the most compelling. While TSMC (TSM) has become what I consider overvalued at this time, STM remains positioned for an attractive entry.

Overview & Updates

STM plays a vital role in semiconductors as it relates to the electronics value chain. Its semiconductor solutions span from discrete and standard commodity components to complex system-on-chips (‘SoCs’). Its product lines are divided into the following segments:

1. Automotive and Discrete Group: It focuses on automotive integrated circuits (‘ICs’), discrete power transistors, and diodes. It comprises 45.4% of the total operating revenue.
2. Microcontrollers and Digital ICs Group: It focuses on microcontrollers, memory chips, and digital ICs, catering to a range of applications from industrial automation systems to consumer electronics. It comprises 31.4% of the total operating revenue.
3. Analog, MEMS, and Sensors Group: It offers a variety of analog ICs, Micro-Electro-Mechanical Systems (‘MEMS’), and sensors. It comprises 23.1% of the total operating revenue.

A large percentage of STM’s operating revenue comes from Singapore, but it is well geographically diversified, with its full geographic diversification broken down as follows:

1. Singapore: 47.1% of operating revenue.
2. Switzerland: 33.3% of operating revenue.
3. USA: 13.2% of operating revenue.
4. Japan: 5.1% of operating revenue.
5. France: 0.9% of operating revenue.
6. Italy: 0.3% of operating revenue.
7. Other countries: 0.1% of operating revenue.

On March 5, 2024, STMicroelectronics introduced new state-of-the-art wireless microcontrollers to meet upcoming cyber-protection regulations. As they support multiple wireless technologies and meet the most recent security compliance, they are ideal for smart industrial, medical, and consumer devices.

On March 7, 2024, it announced the release of new devices from the second-generation STM32MP2 series of industrial microprocessors. They significantly improve performance in smart factories, healthcare, and infrastructure and are armed with 64-bit processing and edge AI acceleration.

Additionally, STM has collaborated with Airbus (OTCPK:EADSF) to improve power electronics for aircraft electrification. This R&D collaboration to advance power semiconductors is crucial for the effective transition to hybrid and full-electric in the aerospace industry.

Market Position & Competitive Analysis

STMicroelectronics excels in the Silicon Carbide (‘SiC’) sector and is one of the world’s largest semiconductor companies. However, the firm faces significant competition from companies like Infineon (OTCQX:IFNNY) and ON Semiconductor (ON). In the broader semiconductor market, the largest peers include TSMC, Intel (INTC), and QUALCOMM (QCOM).

Consider the following market share breakdown provided by Thomas Alsop and Statista, which does not include TSMC as a dominant reading, likely as it operates fabs rather than performing semiconductor development:

As of 2023, STMicroelectronics ranks 8th on the list, which is significantly high in a heavily concentrated and competitive industry.

The semiconductor industry outlook for 2024, as reported by KPMG, is cautiously optimistic. Semiconductor executives are expressing confidence in revenue growth despite concerns about talent acquisition, R&D spending, and capital expenditures as it relates to keeping up with high levels of innovation in technology demand and capabilities. The anticipated growth comes with these challenges, and strong forecasts are driven by the increasing demand for artificial intelligence and automotive technologies. Consider the following excerpt from the report:

• More than 8 in 10 (83 percent) project their company’s revenue will grow over the coming year, which is in line with last year’s 81 percent. However, the rate-of-growth projections are slightly lower. This year, 4 in 10 leaders expect revenue growth of more than 10 percent. While still healthy, a full half of respondents (5 in 10) felt this way last year.
• Executives are significantly more enthusiastic than last year about industry revenue growth—85 percent forecast the industry’s revenue will grow in the coming year, compared to just 64 percent last year.

It is worth also understanding that the demand for Silicon Carbide in the semiconductor industry is growing due to its superior properties compared to pure silicon. It offers notable advantages, including higher efficiency, greater heat resistance, and the ability to operate at higher voltages and frequencies. As such, Silicon Carbide is perfect for energy-efficient power electronics, electric vehicles, and renewable energy systems. In other words, Silicon Carbide technology is the foundation for the future of advanced technology, the other main competitor being Gallium Nitride (‘GaN’). GaN offers advantages in high-speed switching applications, compactness, and efficiency at higher voltages. Thankfully, STMicroelectronics is involved in both SiC and GaN technologies. Its high exposure to these technologies and portfolio of capabilities fundamental to advanced driving, device efficiency, and renewable energy puts the company in a wonderful position in the market to invest in heavily for the long term, in my opinion.

Financial Analysis

I believe STM offers exceptional long-term financials, and recent analyst estimates indicate EPS contractions in fiscal 2024. Therefore, I consider this an excellent opportunity to buy into the company at lowered investor sentiment.

We should compare STM to its leading competitors, IFNNY and ON. First of all, consider it on net income margin against these peers:

This shows that STM ranks highly in profitability, which is further confirmed by its A+ grade Quant rating. Its net income margin of 24.36% is 797.04% higher than the sector median of 2.72%.

While STM’s YoY and forward revenue growth show less promise, I expect these conditions to be temporary, with consensus revenue growth estimates of -6.55% in fiscal 2024 rising to 9.16% in fiscal 2025. Past these, I expect the market to continue to fuel high growth for STM over the long term, and I attribute a lot of the present slowdown to wider macroeconomic slowdowns, which are affecting the demand for consumer goods and the cost of borrowing, inhibiting the purchase of goods and services provided to businesses by STM.

One of the most promising points of investment in STM is its balance sheet, which has a strong equity-to-asset ratio at this time of 0.68 and a 10-year median for the ratio of 0.58. Consider how this compares to ON Semiconductor and Infineon:

• On Semiconductor: Equity-to-asset ratio of 0.59, and 10-year median for the ratio of 0.42.
• Infineon: Equity-to-asset ratio of 0.61, and 10-year median for the ratio of 0.57.

This shows STM to have the strongest balance sheet of the three, and its strength is further consolidated when analyzing the cash flow statement, which shows almost no issuance of common stock in the last decade, and share repurchases every year. Additionally, while it issues debt frequently, it pays this back at suitable and regular intervals, meaning its repurchase of common stock is warranted by a balance sheet that does not suffer at the expense of bolstering shareholder value. For most companies, I tend to believe an equity-to-asset ratio of under 0.5 indicates a firm should be focused on reducing leverage rather than increasing short-term shareholder equity.

Valuation

Incredibly, STM is not trading at a significant premium at this time, and so it performs remarkably well in a discounted earnings model. First, consider its price-to-earnings ratio by GAAP standards of 10.67, which is a -64.3% difference from the sector median of 29.89.

For my discounted earnings model, I have opted for a conservative 15% EPS growth rate as an annual average for 10 years for my growth stage. Following this, I have used a standard inflation-level 4% EPS growth rate as an annual average for 10 years for my terminal stage. I applied a 10% discount rate, which is my low-end annual portfolio return expectation. My fair value estimate from the calculation is $112.12 per share, a 61.04% margin of safety on the present stock price of $43.68. I would consider this estimate a mid-level outcome, indicating exceptional value based on even highly conservative growth outcomes. Without being speculative, an indicated EPS CAGR for 10 years of 20% would lead to a margin of safety of 72.28% at the time of this writing. I believe this is a significant and rare opportunity for a company that is so well positioned as a foundational building block of a growing digitalized economy focused on advanced technology that will be dependent on SiC and GaN.

I have chosen to perform my valuation calculation using expected future earnings rather than cash flows as I tend to believe this more accurately incorporates the expected heightened levels of investor sentiment that usually correlate en mass with earnings over cash flows. While I consider cash flow to be the more reliable metric for long-term business fundamental value, investor sentiment is increasingly important in markets that add significant premiums to stocks over time, and I want this to be as reflected as possible when performing this particular valuation.

Risks

However, as Mare Evidence Labs elucidated, there are risks at the moment with China restricting the use of foreign smartphones. This could impact STM, as it has business ties with major clients like Apple (AAPL). These moves also underscore a period of heightened geopolitical instability between US economic interests and those of the Chinese at this time. The battle for supply chain dominance and infrastructure provision means that both parties could experience revenue and earnings contractions if conflicts escalate.

As mentioned above, and as outlined by KPMG, STM will also face talent acquisition and retention challenges that are crucial when considering how successful the firm will be at adapting to new technological capabilities and demands created by the abilities of other companies it competes with. It is more difficult than it appears from the data to stay actively relevant in a fast-moving industry that is dominated by larger and more well-financed peers.

Conclusion

From my analysis, I believe STM deserves a Buy rating at a small allocation in well-diversified portfolios. The company is strategically positioned in a high-growth portion of the semiconductor market, and its stock looks immensely undervalued to me, considering the future operational strengths I have outlined. In my opinion, it aligns with Infineon as one of the two best semiconductor companies to consider taking a stake in at this time.