Home>Video>Building Moats, One Chip at a Time

Building Moats, One Chip at a Time

Fri, 4 Sep 2015

Chipmakers today are carving out competitive advantages through their proprietary chip designs, high customer switching costs, and exposure to the burgeoning market for electronic systems in vehicles.

+

Video Transcript

Brian Colello: Often in technology, investors are skeptical of economic moats because of the constant fear of disruption. But for a variety of reasons, we don't see this in analog semiconductors. Our review of the industry looks at several firms with wide and narrow economic moats, such as Analog Devices (ADI), Linear Technology (LLTC), Microchip (MCHP), Maxim Integrated (MXIM), and Texas Instruments (TXN).

Looking at the industry, we think these firms have built economic moats based upon intangible assets around proprietary chip designs. This expertise is based off of decades of work from talented engineers. We view analog-chip design as more of an art than a science. We think it takes years of trial and error for these chipmakers rather than simply shrinking transistor sizes or learning designs from a textbook.

The second source of economic moat that we see in the analog space is from switching costs. Analog chips are low-priced parts--often less than one dollar--so design wins are often based on performance rather than price. When customers select an analog part, they tend to stick with it for the life of the product. The economics to switch to a competing part rarely makes sense, and the engineer will rarely run the risk of using a lower-quality part just to save a few pennies on a chip.

Looking at growth opportunities in analog, we see the automotive end market as most promising. The short story here is that analog chips are key components in the rising secular trend of increased electronics content per car, whether it's advanced safety systems (like radar, blind-spot detection, lane-departure warning, and parking assist), whether it's the rise of increasingly advanced "infotainment" systems--both in mass-market cars and luxury cars--increased connectivity solutions throughout the car, or more advanced powertrains--both in gas-powered cars and also hybrid and electric vehicles. We think demand will be supported for all of these products all across the value chain.

Governments are mandating safety features and fuel efficiency. Automakers are using these features as differentiators as they compete with one another. The auto-parts makers get to sell more advanced content, and consumer demand for this increased technology is favorable, while the demographics are favorable among consumers.

Picking stocks, we didn't see attractive buying opportunities in analog for the past couple of years; but in recent weeks, we've seen a bit of a sell-off. We're starting to see a margin of safety in a high-quality name like Linear Technology, at or below $40 per share. We also like Infineon Technologies (IFNNY), which is a no-moat name, but it's trading about 20% below our fair estimate--both in European and U.S.-traded shares. In addition, Infineon has terrific exposure to this fast-growing automotive market.

Just as important, the industry is cyclical, and sentiments can change quickly. So, we'd buy most of these firms with a larger margin of safety if we do get to see a bigger pullback.

  1. Related Videos
  2. Related Articles
  1. 3 Ways to Simplify Your Financial Life in Retirement

    Retirees can streamline their finances by collapsing multiple IRAs into a single account and taking advantage of technology, says Morningstar's Christine Benz.

  2. Unearthing Value in Bonds

    Panel discussion: TCW's Laird Landmann, Loomis Sayles' Elaine Stokes, and Gibson Smith of Janus explore potential areas of opportunity in the credit markets, the prospect of a liquidity crisis, and more.

  3. Friday Five: What Will Weigh on the Fed?

    Tame inflation and overseas concerns could stop the Fed from raising rates in September despite signs of stability in the labor market. Plus: Apple's new way of selling iPhones, a new track for United Airlines, and more.

  4. Does Sustainability Weigh on Fund Performance?

    Ingrid Dyott from Neuberger Berman thinks considering ESG factors makes them more thoughtful investors.

  5. 3 Contrarian Picks for Fund Investors

    Delafield, Lateef, and Mairs & Power Growth have all suffered recently due to their heavy stakes in beaten-down sectors, but they could spell opportunity for patient investors, says Morningstar's Russ Kinnel.

  6. Top Funds for Tax-Efficient Bucket Retirement Portfolios

    Tax-managed, index, and municipal-bond funds from Fidelity and Vanguard are among the best options for investors looking to minimize the tax drag on their portfolios, says Morningstar's Christine Benz.

  7. Active vs. Passive Investing in Retirement

    Retirees can appreciate the low costs, tax efficiency, and simplicity of index funds, but active funds can be better choices in some parts of the market, says Morningstar's Christine Benz.

  8. Go Active or Passive in Emerging Markets?

    For investors who are worried about overexposure to China's volatile market, active funds may be a better option, says Morningstar's Patty Oey.

©2017 Morningstar Advisor. All right reserved.