On Thursday night the CEO of Microchip Technology, Steve Sanghi, made a statement that shocked the market. Mr Sanghi revealed that according to current sales figures and feedback from suppliers, the semiconductor market is about to enter a cyclical downturn. Specifically, Mr Sanghi stated:
“We believe that another [semiconductor] industry correction has begun and that this correction will be seen more broadly across the industry in the near future.”
This revelation hit the semiconductor sector hard, with the shares of industry leader, Intel falling 4% and smaller companies declining between 7% and 10%. ARM Holdings’ (LSE: ARM) (NASDAQ: ARMH.US) shares also fell on the news.
Investors took the statement from Microchip Technology to heart because of the way the company operates. Indeed, Microchip’s supply chain is shorter than that of its peers, so the company usually sees industry trends develop before others. For this reason, according to Mr Sanghi depending on supply chain management and peer accounting methods, it can take months for a slowdown to be reflected across the whole industry.
High expectations
For ARM, the news of a cyclical slowdown is not necessarily bad news. The company’s semiconductors are in demand around the world, so while sales growth might slow, ARM’s profitability is unlike to take a huge hit.
Nevertheless, the market has got used to ARM’s rapid rate of growth over the past five years and as a result, the company’s shares trade at a lofty forward P/E of 36.2. So, as with all high-growth companies, there’s little room for disappointment and if sales start to slow, ARM’s shares could suddenly nose-dive.
Set for a fall
City analysts have already begun to weigh in on ARM’s future, now that Microchip is predicting a downturn in the semiconductor market.
The City believes that ARM’s revenue and royalty growth will remain well below that seen during the last three years. High demand for the Apple iPhone 6 will more than offset weak demand for Samsung smartphones during the near-term. However, analysts are concerned about the state of the industry over the long term, as there are few signs of a sustained recovery in the demand for high-end smartphones.
Still, ARM has been trying to branch out into other markets, away from its key smartphone market for some time but the company’s sales growth is still correlated to smartphone demand. Falling demand for smartphones is bound to hit ARM’s growth rate.
If the company fails to meet lofty growth targets, then ARM’s shares are likely to re-rate from their already high valuation, to something more suitable for a lower rate of growth.