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Is Germany's Top Chipmaker a Great Value Stock to Buy Now?

Motley Fool - Wed Oct 25, 2023

The electrification and digitization process of the automobile is well underway and could be a top technology trend for many years to come. But that doesn't mean the transition will be smooth. The market got spooked this year as electric vehicle (EV) sales hit speed bumps and China -- the largest EV market -- struggles to rekindle economic growth.

As a result, top automotive chipmaker and Germany's (and thus Europe's) largest semiconductor manufacturer, Infineon (OTC: IFNNY), has fallen hard as of late. Shares currently trade for less than 13 times trailing-12-month earnings. Does that make this a top-value stock to buy now?

Europe's big bet on chips

Infineon may not be a household name, but it's a big player in the world of chips. It got its start as German industrialist Siemens' in-house semiconductor unit before getting spun off as an independent business in 1999.

Infineon is an integrated device manufacturer (or IDM, a company that designs and manufactures chips) and was the largest supplier of semiconductors in the auto industry in 2022 -- with fellow European chipmakers NXP Semiconductors (NASDAQ: NXPI) and STMicroelectronics (NYSE: STM) dialing in at No. 2 and 3. Other peers in power supply chips include Texas Instruments (NASDAQ: TXN) and Japan's Renesas (OTC: RNECY) in the world of microcontrollers.

Besides automotive, Infineon is also a top player in supplying semiconductors for the energy grid, communications networks, and other industrial applications like factory automation.

Europe has big ambitions in the semiconductor realm. The continent relies heavily on the automotive industry, so the seismic shift set off by EVs represents a potential threat to the continent's economy. Germany's Volkswagen is the world's largest auto manufacturer, and Germany is a top producer of cars. It's no surprise, then, that Europe would bet big on the semiconductor market. Funding from the European Chips Act (similar in scope to the U.S. CHIPS Act) aims to take Europe from about 10% market share of global chipmaking to about 20% by 2030.

If even partially successful, big ambitions for European automakers and chipmakers could lift Infineon higher for the rest of this decade.

Infineon may not be quite as cheap as it appears

Infineon is coming off a strong spate of growth in the last couple of years, but it's now slowing. Automotive and energy grid demand remains strong, but consumer electronics (especially PC and smartphone) is a sore spot. It seems consumer demand has bottomed, and gradual growth may come back in 2024.

Infineon holds up well compared to some non-diversified peers in the chip market. However, there are some things to consider before buying on the expectation that growth will resume in 2024 and beyond.

First, the company tends to report lower operating profit margins than some of its largest peers. That also includes those based in Europe, which, unfairly or not, is often critiqued as a poor market for chipmaking, given high tax rates and the lack of a large pool of electronics manufacturing talent compared to Asia. These lower operating margins could represent room for improvement, which could translate to a bump up for the stock. Or it could indicate Infineon simply isn't as efficient as its peers, and thus better investments exist.

IFNNY Operating Margin (TTM) Chart

Data by YCharts.

Also, free cash flow (FCF) is down as two big factory construction projects are underway. One is in Dresden, Germany, which will be the site of a large $5 billion investment in analog and power chips, with production of chips slated to begin in 2026. The other facility is an expansion of a facility in Kulim, Malaysia, which Infineon claims will be the largest silicon carbide (SiC) chip facility in the world. Infineon hopes to cross the 1-billion-euro-per-year revenue mark by 2025 and scoop up 30% SiC market share by the end of this decade. Currently, SiC chipmakers STMicro and ON Semiconductor are already on track to surpass $1 billion in SiC sales per year.

IFNNY Free Cash Flow Chart

Data by YCharts.

Given these construction projects and the likely elevated costs to build them over the next few years, Infineon isn't quite as cheap as the price-to-earnings ratio of under 13 seems to indicate. The stock trades for 34 times the trailing 12-month FCF. There is a similar effect taking place at other large IDMs, like Texas Instruments, which has announced big spending plans to keep up with long-term chip demand.

With this period of extended cash outflow for construction, I think chip manufacturing equipment company stocks are a better buy right now than stocks like Infineon. Germany's top chipmaker may look like an attractive value stock, but there's more going on under the hood as it gears up for changes in manufacturing among top customers like the automotive industry. Nevertheless, keep tabs on this stock as it could be a top way to play long-term secular growth trends like the advancement of EVs.

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Nicholas Rossolillo and his clients have positions in ON Semiconductor. The Motley Fool has positions in and recommends Texas Instruments and Volkswagen Ag. The Motley Fool recommends NXP Semiconductors and ON Semiconductor. The Motley Fool has a disclosure policy.

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