Two weeks ago, chip investors were riding high as the sector’s benchmark index rallied more than 50% in anticipation of a promising earnings season. Coupled with the growing excitement surrounding artificial intelligence, chip investors were optimistic about an imminent recovery for the industry.
However, the recent earnings reports from Taiwan Semiconductor Manufacturing (TSM), Texas Instruments (TXN), Intel (INTC), and Advanced Micro Devices (AMD) have revealed that much of this enthusiasm was misplaced.
TSMC raised concerns by highlighting the deterioration of demand across its major end markets, including computers, servers, and smartphones. Likewise, Texas Instruments, a chip maker that supplies products in nearly every sector, acknowledged weakness in its main markets, with the exception of automobiles.
The most surprising revelation has been the slower-than-expected recovery in China. Just three months ago, Intel spoke of “green shoots” of positive momentum arising from the world’s second-largest economy. The general consensus on Wall Street was that China’s economy would continue to surge following the lifting of Covid-19 lockdowns. However, Intel and TSMC now say that China has not rebounded as anticipated, and they expect the country to have a negative impact on their businesses for the remainder of the year.
This development holds significant implications since the second half of the year is when chip companies generate the majority of their revenue. Last year alone, China accounted for $180 billion in sales, representing 31% of the industry’s total sales, according to the Semiconductor Industry Association.
The chip industry now faces a setback as chip makers grapple with unexpected challenges in demand and the prolonged recovery in China. The optimism that once surrounded the sector has taken a hit, leaving investors to reassess their expectations for the coming months.
The Growing Importance of AI in the Chip Industry
The demand for AI-related chips and projects is undeniably on the rise. However, there are a couple of key issues to consider. Firstly, in terms of overall business size, AI-related revenue remains relatively small for semiconductor companies other than Nvidia (NVDA). Take TSMC as an example; they recently disclosed that AI accounted for only 6% of their revenue, which was not enough to compensate for the decline in chip demand. Secondly, while there is increased spending on AI, it has not been additive. Instead, cloud companies are redirecting their budgets from legacy hardware towards AI-related chips.
This trend has also affected major players like Intel, AMD, and TSMC, who have reported a softness in the traditional data center aspects of their businesses due to this cannibalization by AI.
According to Intel CEO Patrick Gelsinger, cloud customers are heavily investing in high-end AI training environments, thus prioritizing the AI segment of their build-out. This shift in resources has brought disappointments as a result of a weak Chinese market, a lackluster industry recovery, and the complexity of the AI boom. Consequently, share prices across the chip sector have dropped, with TSMC, Texas Instruments, and AMD stocks experiencing approximately a 7% decrease. The only exception is Intel, whose return remains relatively flat.
Unless there is a genuine improvement in the fundamentals of the industry, the road ahead for chip companies may continue to be challenging throughout the rest of the year.
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