Note from Daily Trade Alert: The following article first appeared in The Growth Stock Advisor, a premium newsletter offered by Investors Alley.

There is a growing shortage of semiconductors globally.

For proof, look at the auto industry, which is facing a severe lack of semiconductors thanks to rising use of the chips in other products, including smartphones and communication base stations.

Automakers from General Motors to Volkswagen to Nissan to Honda and others are being forced to cut production; some companies may reduce theirs by 10% to 20% per week beginning in February if fears over shortages are realized because the parts makers that supply them have struggled to secure semiconductor supplies from their contractors.

Bosch, the world’s largest car-parts supplier, said it was receiving “significantly fewer” chips for the components it manufactures.

Another major auto parts supplier, Continental, said there was “extreme volatility” in motor supply chains.

And France’s Valeo also said it was seeing shortages in the market.

Where Are the Chips?

This is hitting the auto industry at a particularly bad time, as it moves toward the production of more and more electric vehicles (EVs).

Semiconductors have become crucial for the auto industry as electric vehicles become more popular. According to KPMG Japan, an EV uses twice the number of semiconductors compared to that of a gasoline-powered vehicle.

Semiconductors power everything from battery management, to driver assistance systems as well as in-car entertainment.

With lead times of six to nine months, the semiconductor industry has not been able to scale up fast enough to meet this unexpected growth in automotive demand, which comes on top of a coronavirus-fueled increase in the use of PCs and smartphones.

A major cause of this supply bottleneck comes from the semiconductor industry’s horizontal configuration, in which production and development are separate, with each manufacturer specializing in a particular task.

More and more chipmakers place orders with contract manufacturers instead of fabricating chips in-house. It takes time to manufacture semiconductors while re-configuring lines to accommodate varying specifications, making it tough to turn out different chips at the same time.

This semiconductor industry reality is why orders to Taiwan Semiconductor Manufacturing (TSM), the world’s largest contract manufacturer, is backlogged for the next six months. (Note: I recommended TSM again in December.) And it’s why auto supplier Continental has said that “it will possibly take half a year” until supply for vehicle semiconductors normalizes.

It may even be longer. The problem is that auto companies are lower down on the priority list than companies like Apple. The auto sector doesn’t pay as much for its semiconductors as tech firms do.

In straightforward terms, semiconductor companies are struggling to meet the surge in demand as orders for different types of semiconductors pour in.

You may be wondering which companies are the big suppliers to the auto industry.

Chip Company for the Automakers

The auto industry’s largest chip suppliers include Infineon Technologies (IFNNY), NXP Semiconductors (NXPI), Texas Instruments (TXN), Renesas Electronics (RNECY) and Nvidia (NVDA).

NXP’s CEO Kurt Sievers told German media that a sudden surge in orders from automotive clients was causing supply bottlenecks. However, NXP has a unique challenge. With around half of its business related to the automotive industry, the challenge was that orders typically take three months to deliver, rather than its capacity being given over to other clients like tech companies. Some customers simply ordered “too late” (maybe because of the pandemic?), Sievers said, which had put “significant strain” on its supply chain.

With its large exposure to the auto industry, NXP may be an interesting play on EVs, which likely explains why Qualcomm was interested in acquiring the company.

Let’s take a closer look at NXP…

The company divides its business among four end-markets: automotive, industrial and Internet of Things, mobile devices, and communications infrastructure, but its most important end market is the automotive industry. NXP is the largest supplier of chips to the automotive industry, with a 13% share. This strong position will help to ensure that the company is able to benefit from rising electronic content in the automotive market.

NXP is also involved in the move toward autonomous vehicles. The company provides co-processors into some advanced driver-assist systems (such as the one made by Mobileye). NXP supplies the safety processor that helps the vehicle transition safely in the event of a driving assistance system failure.

Another plus for NXP is its “sticky” customer base. Once a company’s product has been incorporated into a design,

it is likely to remain in place for the duration of the design life cycle. This results in high switching costs for

NXP’s automotive customers.

The same applies to certain of its industrial customers (particularly those purchasing industrial controls and factory automation solutions) and communication infrastructure customers (such as in transit systems).

Finally, the rapid growth of electronic content in the automotive market should be one of the major growth drivers for NXP. Sales from the segment (currently about 40% of total revenue) should grow at a low double-digit pace from 2021 through 2024 as the global automotive industry recovers from the coronavirus pandemic.

There are still questions about when the recovery from the pandemic will truly begin. So for that reason, I will keep NXP Semiconductors at just four stars. You can buy it at any price up to $200 a share.

What Do the Stars Mean?

I give each stock a rating of up to five stars. Here’s a brief explanation of the star rating system:

  • Five stars: Our highest rating. This means the stock is a strong buy.
  • Four stars: This means the stock is a buy, but is just shy of our maximum confidence level.
  • Three years: Hold. If you own it, there’s no reason to sell it. If you don’t own it, there are better buys out there.
  • Two stars: This is a sell. If you own it, it’s time to sell.
  • One star: Strong sell. Stay far away from it

Tony Daltorio
January 18, 2021

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Source: The Growth Stock Advisor