Chip Stocks Have a Problem in China

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Red Scare. Hi everyone. Two weeks ago, chip investors were riding high. Expectations were elevated after the sector’s benchmark index rallied more than 50% heading into earnings season. On top of the rising excitement around artificial intelligence, chip investors saw an imminent recovery for the industry.

But then came earnings. Recent results from four of the largest chip makers—
Taiwan Semiconductor Manufacturing
(ticker: TSM),
Texas Instruments
(TXN),
Intel
(INTC), and
Advanced Micro Devices
(AMD)—have made it clear that much of the enthusiasm was misplaced.

TSMC sparked the worries by noting that demand from all its major end markets—computers, servers, and smartphones—had deteriorated more than expected.
Texas Instruments,
a chip maker that sells the basic building-blocks that go into products in nearly every sector, also said its main markets were weak—with the exception of automobiles.

The biggest surprise, however, has been the slower-than-expected recovery in China. Three months ago, Intel told investors that it saw “green shoots” of positive momentum from the world’s second largest economy. The Wall Street consensus became that China’s economy would continue to soar after Covid-19 lockdowns were lifted. But that narrative is now gone. Intel and TSMC said China hasn’t rebounded as expected, noting that the country would negatively affect their businesses for the rest of the year.

This is a big deal. The second half of the year is when the majority of revenue is generated for most chip companies. According to the Semiconductor Industry Association, China generated $180 billion in sales, or 31% of the industry’s total sales last year.

What about AI? There’s no doubt that demand for AI-related chips and AI projects is surging. But there are two issues. First, is the relative size of the business. For basically every semiconductor company other than
Nvidia
(NVDA), AI-related revenue is still a fraction of sales. TSMC is a good proxy. The company recently said that AI represented only 6% of its revenue and wasn’t enough to offset the aggregate drop in chip demand. Second, AI spending thus far hasn’t been additive; instead, cloud companies are shifting spending to AI-related chips and away from legacy hardware.

Intel, AMD, and TSMC all noted similar near-term softness in the traditional data center parts of their businesses, reflecting this AI cannibalization.

“We do see that big cloud customers, in particular, have put a lot of energy into building out their high-end AI training environments. And that is putting more of their budgets focused or prioritized into the AI portion of their build-out,” Intel CEO Patrick Gelsinger said on the company’s earnings call.

The disappointments from a weak China, a lackluster industry recovery, and the nuanced AI boom have hurt share prices across the chip sector. Since their respective earnings reports, TSMC, Texas Instruments, and AMD stocks are each down roughly 7%. Intel is the lone exception, with a roughly flat return.

Unless the fundamentals genuinely turn around, it may be tough sledding the rest of the year.