An Ultracheap Stock to Buy in a Rallying Sector

STMicroelectronics STM is a key chip supplier to the industrial and automotive end markets. Although the narrow-moat company recently provided a soft forecast for 2024, ST is one of our top picks in the tech sector as near-term automotive weakness—especially in electric vehicles—seems overdone. The stock is undervalued, trading well below our $66 fair value estimate. STMicroelectronics made our elite list of 5 Ultracheap Stocks to Buy With the Best Returns on Investment.

STMicroelectronics is one of Europe’s largest chipmakers and holds one of the broadest product portfolios in the industry. The company’s leading technologies and strong position in the automotive market are reasons to be optimistic about the future, with especially promising opportunities in silicon carbide-based power products. The automotive industry is focused on safer, greener, smarter cars, which is leading to increased electronic content per vehicle. Broad-based chipmakers like ST stand to profit from greater demand for advanced infotainment systems, battery management solutions, and sensors associated with new safety features like blind-spot detection. Broad-based microcontroller sales also appear to be a nice growth avenue.

Key Morningstar Metrics for STMicroelectronics

• Fair Value Estimate: $66
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: High

Economic Moat Rating

We assign ST a narrow economic moat rating, consistent with other broad-based analog, microcontroller, and power semiconductor companies, thanks to intangible assets stemming from its design expertise as well as customer switching costs: Its products are rarely ripped out once designed into a given electronics device, particularly in automotive, industrial, and Internet of Things applications. The majority of ST’s revenue comes from segments that, in our opinion, would warrant a narrow moat rating in isolation—mainly analog, digital, and automotive chips. The discrete power chip business is potentially developing design expertise in silicon carbide-based semis, but we think the moat case is less clear-cut and would rate this business in isolation as having no moat.

Read more about ST’s moat rating.

Fair Value Estimate for ST Stock

Our fair value estimate is $66 per American depositary receipt. We anticipate that ST will increase revenue at a 5% compound annual growth rate over the next five years off a near-term revenue peak in 2023. Coming off a down year in 2024, ST will increase revenue at an 8% average annual pace from 2025 to 2028 and achieve its $20 billion revenue target in 2027, in our forecast. We don’t have heroic assumptions for ST on the gross margin front; we only model a return to the high 40s in the long run, short of management’s 50% target. The majority of ST’s sales and cash are in US dollars, but the majority of its costs are in euros. As a result, the company is susceptible to exchange-rate fluctuations. Our valuation assumes a constant dollar/euro exchange rate for our five-year forecast period.

Read more about ST’s fair value estimate.

Risk and Uncertainty

STMicroelectronics has to navigate chip industry cycles, and it has especially high exposure to European manufacturers, so any slowdown in European GDP could hurt chip orders. We think ST carries some risk associated with its in-house manufacturing capacity, as it has to generate enough revenue to cover the high fixed costs of its advanced chip factories and earn excess returns on capital. Given the need for further research and development and ongoing capital expenditures, ST’s profitability, while improving, may lag that of several of its US-based rivals. Also, the company needs to continually innovate in order to retain the business of leading smartphone vendors like Apple and Samsung.

Read more about ST’s risk and uncertainty.

ST Bulls Say

• ST has an early lead and is recognizing exponential growth in silicon carbide-based power semis, most notably those included in the inverters in Tesla’s electric vehicles.
• Chipmakers with heavy automotive exposure, like ST, should profit from the secular trend toward more advanced electronics content in cars over the next few years.
• If US-China trade tensions continue, Chinese chip buyers could decide to shift away from US analog and microcontroller suppliers and instead buy from neutral Europe-based companies like ST.

ST Bears Say

• ST has a greater presence in certain types of lower-margin power semiconductors that, when combined with significant manufacturing capacity, may depress future returns relative to some of its US-based pure-play analog peers.
• Apple is an important customer, and it would be a damaging blow if ST were to ever lose its content in future iPhone models.
• ST is partially owned and controlled by the French and Italian governments, which raises doubts as to whether it is truly focused on operating efficiency.

This article was compiled by Susan Dziubinski and Sylvia Hauser.