The announcement of Nvidia’s 4-for-1 stock split the other day snapped the chipmaker’s month-long slide and sent shares back up toward all-time highs.
It’s not undeserved, either.
The company has been a huge overall benefactor from the pandemic, with both gross profit and revenue up 61% year-on-year.
Quarterly revenue at $5 billion and profit at $3.2 billion are absolutely MONSTER numbers for a company of that size.
And at this point in the business cycle, the crypto crowd’s favorite coin-mining GPU (graphics processing unit) manufacturer is nowhere near done going up.
After acquiring chip-architecture specialist Arm in September of last year, they began working on a data center central processing unit, or CPU. And the resulting product — which the company calls “Grace” — was released to much fanfare about a month ago.
But more importantly, this release has turned them into what CEO Jensen Huang described as a “three-chip company,” producing a core supply of GPU’s, CPU’s and data processing units, or DPU.
This sends them LeRoy Jenkins-style into direct competition with Intel and AMD, in a quest to be what Huang called “the basic building block of the modern data center.”
But one question still remains… Will they even be able to meet demand?
Sure, Nvidia’s year-on-year growth was massive… Conditions were ripe for it.
The pandemic forced everyone to work from home, which pushed up demand for devices, all of which require chips.
But the demand that got pulled forward because of the pandemic also caused a global slowdown in the rate of chip manufacturing. And that makes sense… It’s hard to manufacture a chip if the government closes down your business for a month or two.
Lots of demand, plus a dwindling supply, however, means that prices have to go up.
And boy did they.
On a year-on-year basis, the increase in input costs for microchip manufacturers far outpaced sales, with costs (in red) rising 69% versus around 60% apiece for revenue and margin (in blue).
Source: Seawolf Research
In other words, costs are going up faster than they can pass them on to the consumer.
Economists have a technical term for this… It’s called inflation.
And sadly, it’s going to remain a problem going forward, as lead times for microchip orders have ticked up to 18 weeks from a norm of around 12-14 weeks. That’s roughly a 30-50% increase.
And coupled with other inflation/supply chain problems, we are now at the longest wait time in HISTORY for manufacturers.
Unfortunately, this delay in delivery times comes at the very same time that total retail sales exceeded inventories for the first time in HISTORY…
And that is, of course, causing retail inventories to head back down toward their June 2020 lows.
Keep in mind, this is all happening with 16 million people still collecting some form of unemployment. And although that’s a huge improvement from the peak, it’s still well above the worst level we ever experienced during the Global Financial Crisis.
As all those unemployed folks begin to get vaccinated and re-enter the workforce, do we think that will increase or decrease demand?
I don’t know about you, but I generally spend more money when I have more of it, and less when I have less.
So I’m going with more. That means more pressure on supply, more drawdowns in inventories and more price increases going forward.
In other words, I expect inflationary pressures in the chip space to continue regardless of economic conditions.
And unfortunately for those trying to purchase semiconductors, economic conditions are not cooperating.
To be fair, the short-term headwinds aren’t solely the fault of the economy itself.
In fact, this latest round of supply chain disruptions can be traced largely to a weather-driven raw materials shortage… It just might not be the first raw material that comes to your mind.
I’m talking about water.
You see, chip manufacturing is a highly water-intensive process — an integrated circuit on a tiny 30-centimeter wafer uses 2,200 gallons of water.
And one of the world’s largest producing countries — Taiwan — just happens to be going through its worst drought in over 50 years.
Baoshan No. 2 Reservoir in Hsinchu, Source: BBC
That has not only throttled chip production in the world’s second-largest chipmaking country — led by major producer Taiwan Semiconductor Manufacturing (NYSE: TSM) — but it’s also causing rolling blackouts at the same time that a wave of COVID-19 infections is sweeping the country.
Worse, the primary type of chips that the Taiwanese industry provides the world are logic chips, which serve as the “brains” for the increasingly complex, connected devices that help drive our economy.
U.S. car manufacturers like GM and Ford have already throttled back production due to the chip shortage, and other industrial manufacturers are already following in their footsteps.
And without that production available to pass through increasing prices, it leaves U.S. chipmakers like Nvidia above — 26% of whose costs are accounted for by TSM — with the risk of eating the cost themselves.
Does that mean Nvidia and others are at risk of a near-term drawdown?
I don’t think so… not yet, anyway.
But while prices inflate, I wouldn’t mind having some diversified exposure through the VanEck Vectors Semiconductor ETF (NYSEArca: SMH).
Prices have run up about 10% from recent lows, so keep any purchases small — one-tenth tranche or lower — and try to buy on days when it’s down.
Taiwan is a sub-tropical climate, so their weather could shift at any moment and pull pricing pressure off.
But even if it got hit by a monsoon tomorrow, the industry would still be behind.
This is a situation that we will continue to monitor over the course of the next few months, so keep an eye on your inbox…
All the best,