Infineon: Now Is A Good Moment To Pick Up A First Tranche – Infineon Technologies AG (OTCMKTS:IFNNF)

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Introduction

Infineon Technologies AG (OTCQX:IFNNF; OTCQX:IFNNY) is a German semiconductor manufacturer founded on 1 April 1999, when the semiconductor operations of the parent company Siemens AG were spun off to form a separate legal entity.

The share performance this year was anything but good. Since January 2018, the company has lost half of its value.

(Source: Stock price performance)

The recent price losses since May are due to three events.

  • In May, rumors began to spread that Infineon had suspended the supply to Huawei because of the U.S. export control restrictions announced by the Trump administration. Infineon’s annual sales to Huawei amount to USD 100 million or less. Infineon denied this reports immediately. The company said most of its products were not covered by the U.S. export control restrictions.
  • Infineon adjusted its outlook for the 2019 fiscal year revenue and earnings downward in view of continued global economic uncertainties and weaker end market demand. Especially a number of end markets continued to be sluggish; in particular, the trend of declining vehicle sales in China has accelerated in February, causing dealer inventories to increase sharply. Also, inventories in the broader distribution channel, in particular for Power Management & Multimarket in China have increased.
  • After Broadcom (AVGO) cut its annual sales forecast, saying it would make USD 2 billion less than it expected, Infineon share prices followed Broadcom down.

In the following analysis, I would like to work out whether an investment is worthwhile in view of the price losses or whether investors should rather wait.

The Business

Infineon offers a very broad product portfolio. The company is divided into four divisions:

  1. Automotive
  2. Industrial Power Control
  3. Power Management & Multimarket
  4. Digital Security Solutions

The Automotive division (ATV) offers a broad product portfolio of microcontrollers, intelligent sensors, transmit and receive ICs for radio-frequency applications and radar as well as both discrete and integrated power semiconductors. Accordingly, Infineon develops products and solutions for conventional drivetrains while also actively shaping the keystone trends that define the industry.

Industrial Power Control (IC) products are crucial for generating and transmitting electric power efficiently and with virtually no losses – as well as for reducing energy consumption. The division specializes in the efficient conversion of electric energy along the entire supply chain – from generation and transmission right through to consumption.

Within the Power management & Multimarket (PMM) division, Infineon addresses the growing number of electronic devices we use in our everyday lives. The division focuses on power semiconductors for energy management as well as components for wireless infrastructures and mobile devices. PMM also specializes in ultra-reliable components for applications in industries such as aerospace.

With the Digital Security Solutions (DSS) division, the company offers solutions for digital communication. Based on its core competences in the fields of security, contactless communication and integrated microcontroller solutions (embedded control), Infineon offers an extensive portfolio of semiconductor-based security products for many chip card and security applications. Parallel to its role as an independent business segment, DSS acts as a competence center for the other three segments, supporting their efforts to hardwire security functionality into their respective system solutions.

The company has an impressive market position in all these markets. Infineon is market leader in the market segments “Power Supply,”Security,” “Industrial electronics” and still the second leading company in the “Automotive” market segment.

(Source: Strong market position)

Accordingly, the company has high market shares in all of these markets:

(Source: High market shares)

Infineon has a global footprint too. China accounted for 26 percent of Infineon’s sales worldwide in the first half of the 2019 fiscal year. Therefore, China commands the largest share at the individual country level, followed by Germany at 14 percent. The “Americas” region accounted for the largest share of sales growth with revenue up by 35 percent (in contrast to the previous year, which saw a EUR 21 million decrease in sales):

(Source: Sales by region)

Investors should consider a buy because

Outlook

The significant slowdown in the global economy is leaving its mark on the semiconductor industry. After two strong years with 5.7 percent in the previous calendar year, the semiconductor market is predicted to decline in 2019 by 2.6 percent but to recover in 2020:

(Source: Global Semiconductor Market)

Given that fundamental development, Infineon performed very well in all of the four segments.

(Source: Good performance in all segments)

Nevertheless, for the full fiscal year 2019, Infineon adjusted its outlook:

  • Revenue is now expected to come in at EUR 8.0 billion, up from EUR 7.6 billion in the 2018 fiscal year, plus or minus 2 percent.
  • The growth rate of the Automotive and Industrial Power Control divisions should come in above group average, whereas the Power Management & Multimarket division is expected to grow slightly less.
  • For the Digital Security Solutions division revenue is still assumed to decline by a mid single-digit percent rate compared to the previous year.
  • The margin is expected to be 16 percent, versus 17.5 percent before.

Given the communicated outlook 2019 and the known economic problems in the world, much should be priced into the share price.

Furthermore, the semiconductor market is predicted to recover in 2020. The high price losses are therefore in no way justified in view of the changed outlook.

Fundamental environment

With the recent price losses, Infineon has underperformed most of its competitors in its peer group, except for Renesas (OTCPK:RNECF, OTCPK:RNECY). On the other hand, compared to NXP Semiconductors (NXPI), ON Semiconductor (ON) and STMicroelectronics (STM), Infineon seems still a little bit overvalued:

(Source: Peer Group performance)

Company Infineon Analog Devices NXP Semi-conductor ON Semi-conductor Renesas STMicro-electronics Texas Instru-ments
P/E ratio 16.91 24.89 13.71 13.70 32.29 12.16 19.48
Market Cap 18.21B 38.46B 25.92B 7.856B 7.746B 14.10B 100.68B

(Note: Market Cap of Infineon is without the Cypress Semiconductor merger)

Fundamentally, I believe that this premium is justified. On the one hand, it reflects the existing growth potential. It must also be borne in mind that Infineon operates in promising markets. Global mega trends underline the increasing importance of microelectronics. For example:

  • Energy efficiency/Climate change & resource scarcity
  • Urbanization/Mobility/Digital transformation
  • Security
  • IoT & big data

Infineon is also the market leader in most of these markets (see also above) and will become the number one supplier of chips to the automotive market after the Cypress Semiconductor (CY) deal (see below in more detail):

(Source: Leading position)

However, investors should keep in mind the danger of catching a falling knife. It is not foreseeable how the trade conflict will develop further. Further punitive tariffs or bans such as the Huawei ban could hit Infineon hard and lead to further price losses. On the contrary, the trade war will not last forever and Infineon will strengthen its presence in the US after the Cypress Semiconductor deal (see below in more detail).

In addition, there is an oft-quoted wisdom on the stock exchange: “Political stock markets have short legs.” This means that price fluctuations due to political developments are mainly short term. The long time P/E ratio supports this thesis. Infineon is traded far below its average.

(Source: Long time P/E ratio)

Therefore, a small time window may have opened up for investors in which they can invest cheaply in Infineon.

Dividends

Since the 2010, Infineon has returned dividends to its shareholders. In recent years, Infineon has increased the dividend in several steps, from EUR 0.10 per share for the 2010 fiscal year to EUR 0.27 per share for the 2018 fiscal year:

(Source: Dividend history)

Based on the current share price, the dividend yield is 1.87 percent. Note, however, that – as is customary in German companies – the payment is made only once a year (usually in February) and not quarterly.

The Cypress Semiconductor deal

Two weeks ago, Infineon and Cypress Semiconductor announced that the companies have signed a definitive agreement under which Infineon will acquire Cypress for USD 23.85 per share in cash, corresponding to an enterprise value of EUR 9.0 billion. The offer price represents a 46 percent premium to Cypress’s unaffected 30-day volume-weighted average price during the period from 15 April to 28 May 2019

Cypress has a differentiated portfolio of micro-controllers as well as software and connectivity components that are highly complementary to Infineon’s leading power semiconductors, sensors and security solutions.

The transaction will make Infineon the number eight chip manufacturer in the world. In addition to its already leading position in power semiconductors and security controllers, Infineon will now also become the number one supplier of chips to the automotive market (which is with 43 percent of Infineon’s total sales already the biggest business).

Infineon has decided to increase its share capital. Therefore, 112.773.923 new ordinary registered shares were placed. The offering of new shares at EUR 13.66 via private placement to institutional investors, would increase its share capital by 10%. The timing is of course extremely unfavourable, as the price has already fallen sharply.

Strategically, the merger makes sense for Infineon though. With the addition of Cypress’s strong R&D and geographical presence in the U.S, Infineon not only strengthens its capabilities for its major customers in North America, but also in other important geographical regions. Especially, Infineon gains presence, as well as market share, in the strategically important Japanese market.

Takeaway

After every analysis of a company, I will use a three-grade rating for this series. Its purpose is to ensure that readers recognize at first glance whether a company might or might not be worth investing. The three steps rating at a glance:

Buy the jewel rather now than tomorrow if:

  • There are no downsides and the company has growth potential.*
  • The upsides outweigh the downsides and the company has enormous growth potential.

Worth an investment (maybe later after a second look) if:

  • The upsides outweigh the downsides.
  • The upsides are equal to downsides but the company has growth potential.

No thanks if:

  • No growth potential in the long term.
  • The downsides outweigh the upsides.

*Of course, the growth potential is part of the upsides, but it is also crucial in my final considerations.

The grade for Infineon:

After all, for long-term investors, now the risk reward ratio is good enough to get a first tranche of Infineon shares on board:

  • The upsides outweigh the downsides and the company has enormous growth potential in the long term.
  • The semiconductor market is predicted to recover in 2020.
  • The trade war will not last forever.
  • There may be only a small time window in which investors can invest cheaply in Infineon because political stock markets have short legs.
  • The danger of catching a falling knife still exists, therefore I suggest to buy two or three smaller tranches.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IFNNF, IFNNY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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