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For today’s Soundbites, we talk about semiconductors with Brenda Nicholls, an assistant vice president with Mackenzie Investments and the co-lead manager, along with Martin Rose, of the GLC team’s science and technology fund. We asked what caused the global shortage of computer chips, when supply chains will get back to normal, and we started by asking why computer chips matter so much.

Brenda Nicholls (BN): Semiconductors have really become ubiquitous and in fact they are the world’s fourth-most-traded product. Telecommunications requires semiconductors. In automotive, chips are necessary for proper functioning in engines, transmissions, and many more features. In industrial end-markets, examples range from fluid sensors to factory automation. In consumer applications, there’s smart phones, wearable fitness watches, notebooks, game consoles and other computing devices. As I was doing the research for today, I was like, ‘They’re really in everything!’ So, it’s kind of mind-boggling, actually. The key commonality is the need for ever stronger, faster and more efficient semiconductors to power all of these applications.

The timeline of the current superconductor shortage.

BN: The escalating trade war, which did start in 2019, caused companies in China to stockpile inventory as they worried about their access to U.S.-designed chips. In February 2021, a powerful winter storm in Texas caused power outages around Austin. Samsung’s facility [Samsung Electronics Company of Suwon-si, South Korea] is one of many fab plants impacted there and it wasn’t able to resume normal operations until April. There was also a fire in March 2021 at Renesas’ plant [Renesas Electronics Corporation of Koto City (Tokyo)] in Japan which matters because they provide about 6% of automotive chips globally. Once 2021 is fully reported, chip shortages will have wiped out over $200 billion globally for carmakers with production of an estimated 7.7 million vehicles lost or delayed. In fact, research has shown over 169 industries have been touched by the shortage in some way. That just speaks to the intricacies of supply chains and how interconnected they really are.

When supply chain issues should start to ease.

BN: The short answer is we believe the semiconductor shortages are likely to improve in the second half of this year as the overspending on goods reverts back to more normalized trends. There have been numerous mentions of shortages on company conference calls this earnings season, but we get the general sense that we’re getting through the worst of it. The semi equipment makers themselves see improvement beyond this current quarter. China’s zero-Covid policy may be the one wrench on the road to recovery, particularly if intermittent lockdowns continue to occur over the course of this year.

Who’s weathering the storm and who’s been hardest hit.

BN: Texas Instruments raised inventory in the latter months of 2019 and were rewarded with strong sales growth as the pandemic accelerated demand. Apple [Corporation of Cupertino, Calif.] has very strong relationships with their suppliers, largely based on their size, and they remain at the front of the line to get the chips they need. Ongoing strength in public cloud demand has meant strong growth for Amazon’s AWS [Amazon.com Inc., of Seattle, Wash.], Microsoft’s Azure [Microsoft Corporation of Redmond, Wash.] and Google’s cloud business [Google LLC, of Mountain View, Calif.]. These major players have also started designing their own chips over the past few years in their quest for ever-more-powerful and efficient chips. We think company fundamentals are going to matter, even more so, as the speculative excess is curtailed. A company with a strong revenue growth outlook, which has pricing power and able to generate free cash flow, these are the types of opportunities [that are] going to be in favour this year. Quality software names like Intuit [Inc., of Palo Alto, Calif.] and Adobe [Inc. of San Jose, Calif.] fit the bill. We believe Arista Networks [of Santa Clara, Calif.] and Microsoft will also be key winners.

And, finally, what’s the bottom line in investing in the microchip industry?

BN: Semiconductors as an industry is inherently cyclical. It always has been, and it likely always will be. Chips that are more commoditized are easily replicable. Those are the companies that are likely going to be more at the whims of the cycle. The companies that are able to design the very high-end, high-efficiency, customized chips, those are where the real opportunities lie. All industries are relying more and more on technology, and ultimately all sectors are going to become a technology sector. So as the use cases of the semiconductors broaden out, the opportunities for investments broaden out as well.

Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Brenda Nicholls of Mackenzie Investments.

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