With over 40% of its revenue coming from the auto sector, Infineon (OTCQX:IFNNY) is heavily dependent not just on the nascent recovery in auto builds around the world, but on the future trajectory of hybrid/EV car development, as well as the inclusion of increasingly sophisticated driver safety systems. Considering Infineon’s strong existing position in a range of existing markets – #1 in auto power, #2 in auto sensors, #3 in auto microcontrollers (or MCUs), and #1 in IGBTs (auto and non-auto) – there’s every reason to expect Infineon to leverage meaningful auto content growth over the next decade from both electrification and automation.
Infineon’s recent presentation on its auto business was more evolutionary than revolutionary, but there were some interesting takeaways, including the expectation for meaningful upcoming SiC award announcements. While Infineon management didn’t upgrade its quarterly guidance during the October 5 call, recent announcements from Sensata (ST) and STMicro (STM) should increase investor confidence in the possibility/likelihood of a beat-and-raise quarter. Given relative valuation, I still prefer STMicro to Infineon, but improving end-market demand in autos and factory automation/industrial should increase the odds of upward revisions over the next 12-18 months.
The Auto Recovery Is Underway
Given the upward guidance revisions and the recent trend of improving U.S. auto sales (September was once again above expectations, rising almost 9% month over month), it wasn’t all that surprising that Infineon management said they see a healthy ongoing auto recovery into 2021. While Infineon does expect absolute global production levels at the end of 2021 to still be below 2019 levels, management expects mid-teens growth in 2021, led by China and with the EU likely to be the weakest of the three major markets.
As Infineon generates over 40% of its revenue from auto customers, this is clearly an important part of the 2021 investment outlook. At closer to a third of revenue, it’s likewise very important to STMicro, and other companies like ON Semiconductor (ON), NXP Semiconductors (NXPI), Renesas Electronics (OTCPK:RNECY), and Texas Instruments (TXN) likewise have significant exposure to the auto end-market.
Looking at existing market shares and bills of material, I would argue that Infineon, NXP, and Renesas are the most exposed to this near-term recovery. This veers close to splitting hairs, but with companies like STMicro and ON, a little more of the story is weighted toward future share gains, particularly with hybrid/electrification and ADAS programs.
The xEV Argument Remains Strong
Key to the outlook for so many of these companies, and particularly those leveraged to automotive power like Infineon, ON, and STMicro, is the outlook for hybrid and electric vehicle programs. While the numbers will vary from company to company, Infineon’s slide lays it out pretty clearly – while mild hybrids offer a roughly $176 content uplift, that expands to $430 for full/plug-in hybrids and pure EVs.
Source: Infineon presentation, October 5, 2020
At this point, xEV is not really a money-making proposition for auto suppliers. Not many of these cars are on the road, and companies like Infineon are experiencing high costs related to customization, ongoing R&D investments, and not much operating scale.
Of course, that is expected to change, with government mandates providing a powerful tailwind. California’s governor recently signed an executive order that effectively bars new gasoline and diesel vehicles after 2035 (all cars and passenger trucks sold in California have to be zero-emission), and I believe California accounts for around 10% of U.S. vehicle sales.
Beyond that, several other states are supposedly considering similar directives; whether they’ll withstand almost-certain court challenges is debatable, but there is at least some state-level willpower here. The EU, too, is tightening the screws on automakers, with a new long-term fleet CO2 reduction target that is 38% below today’s level, and frankly only achievable with significant hybrid/EV adoption.
SiC About To Ramp… ADAS, Not So Much
One of the more interesting takeaways from the Infineon presentation was management’s expectation of high-volume silicone carbide (or SiC) platform launches in 2024/25. Today there are only two automakers using SiC in any meaningful way – Tesla (TSLA) and Hyundai (OTCPK:HYMLF), both of which use it for inverters – but to hit a 2024/25 launch timeline, that means there will be significant awards in the coming quarters. Both Infineon and STMicro have talked of sizable backlogs in their SiC businesses, and I think we’re about to see how “close to primetime” these businesses really are.
Longer term, the adoption of SiC for power semiconductors will be a major driver within the auto space, and Infineon, STMicro, and ON have all positioned themselves accordingly. Infineon in particular is looking forward to leveraging its existing strength in IGBTs (over 30% market share) to become the leader in auto SiC IGBT, and the company recently secured a “triple-digit million-dollar” win in the space.
Infineon, though, has also acknowledged the likelihood of competition from up-and-comers in China. As China is a prime market for xEVs (and it is, frankly, a great deal simpler for the Chinese government to force the issue), and as China has grown increasingly leery of relying on foreign suppliers for critical technologies, it’s not a surprise that there are companies looking to fill this demand. StarPower (603290.SS), CR Micro (688396.SS), and Wingtech (600745.SS) are all names to watch, but as readers may gather from the ticker symbols, they’re not easy names for American investors to access at this point.
Another interesting incremental update from Infineon’s presentation concerned the outlook for advanced driver assistance systems (or ADAS). Management was rather confident on the ongoing demand for Level 2 and Level 2+ systems, as well as Level 3 starting in 2021, but they lowered their expectations from Level 4/5 vehicles in 2030 to 2.5 million from 4 million.
Honestly, this largely fits with my own expectations – I’ve thought for a while that autonomous driving bulls were too bullish on their adoption curves, and that most of the growth this decade would be from simply getting Level 0 and Level 1 cars up to Level 2 and 3. For Infineon, advancement beyond Level 4 and 5 isn’t a tremendous driver; the company’s leverage is largely in sensors, MCUs, memory, and power, and while there are advanced needs for Level 4/5 automation, the main value there is beyond Infineon’s capabilities (more relevant to companies like Aptiv (APTV)).
The Outlook
I expect 2021 to be a meaningfully better year for Infineon, with a double-digit recovery in auto builds, meaningful xEV awards, and recoveries in other important end-markets like factory automation. Over the next five years or so, I expect advanced power (inverters, IGBTs, et al) to be a significant growth driver in both the automotive and industrial markets, leading to margin leverage that should push non-GAAP operating margins into the high teens.
The Bottom Line
The only “but” at this point is that all of this is already in my model and, I believe, reflected in the share price. I do expect Infineon to post impressive double-digit FCF growth, and I likewise understand that strong plays on secular growth trends are going to get robust valuation multiples. Even so, I still think Infineon is a little pricy relative to STMicro, and that remains my preferred play on these trends.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
