STMicroelectronics N.V. (STMPA) Earnings Call Transcript & Summary

Hello. Good afternoon, everybody. I'm Dom Olszewski from Morgan Stanley. I head up European semiconductors and tech hardware coverage. I'm very delighted to introduce today Jean-Marc Chery, CEO; and Lorenzo Grandi, CFO at STMicroelectronics. Welcome to the both of you.

Hello.

We're delighted to be propose to you today following recent results. Just as an immediate preset to our investors listening live on the webcast, [Operator Instructions] So welcome to the preview.

Maybe at a very broad opening statement is - or conversation starter would be what is the outlook you're seeing from your end customers today? I believe Jean-Marc, you spoke recently about -- or in the past around orders exceeding your capability of revenue delivery by around 30%. So curious about sort of a comparable figure there and also maybe just a discussion on what you see from your end markets today.

So thank you for the question. I think let's break down, okay, the market we serve in 2 parts. First of all, what we classify stand-alone electronics, covering personal electronics or smartphone, tablet and related accessories. And then, okay, the computer and communication equipment and computer, computer operation. And then there is the other part of the electronics, what we call embed electronics where you have automotive and overall industrial market. Well, first of all, the most simple is stand-alone electronics. So clearly, we continue to see a steady demand and solid demand on, let's say, personal electronics 5G smartphone accessories. And clearly, we start to see a new growth driver, okay, with adequate form factor devices, okay, like the smart glasses coming in soon. So we see this market, okay, really demand solid. Where we see also a solid demand is definitively in server. But you know that we analyze this market selectively, okay, we leverage some general purpose product, but this is basically what we see. We see also a solid demand on -- again, on the communication infrastructure and 5G, but other kind of communication infrastructure like low orbital satellite infrastructure. Now where we see something coming back more to normal after the stay at home effect and the COVID effect it is on the PC market. And in fact, again, okay, here we are more selective. We address this market, okay, with our general purpose device, but this is the view we have. Now it is clear that this market also in starting H2 2021. And in Q4, has been hurt by shortage as well. which was not really the case in H1 2021. But we do believe that progressively in 2022 and for sure in 2023, okay, because of the capacity set-up by the key foundry player, because the key player in this market are most likely fab-less and takes with the capacity set up and invested by TSMC or Samsung or eventually UMC, okay, the situation will improve in terms of fulfillment of the device. Then automotive electronics. Well, clearly, automotive industry, okay, I really would like to insist that what we are facing today is nothing we have seen in the past. It is unprecedented situation because both automotive and industrial are, at the same time, facing a strong growth, which is related to the recovery of the economy post COVID, but they are making a very, very deep and strong transformation, accelerated. And it is well known now, okay, because it is classified smart mobility, so electrification and digitalization of the mobility. And in this call, let's say, automation, transformation of the industry to be more compliant with, let's say, the Green Act to set up industry more in respect of the CO2 emission, but was treatment, new energy, renewable energy usage after the COVID, okay, more automation to be less labor intensive and so on and so forth. And this is a unique transformation. We never ever have seen such transformation coming for new technology, new product, more semiconductor content. And this is a time where the economy overall is recovering. And it is clear that here on the business model, the operating model is a mixed one, mix and match between, okay, fab less, fab light and some specialty foundry or general purpose foundry, but general purpose foundry, which have not invested purposely for mature tech mature 8-inch technology. So here, okay, we see that the demand on electronics, so automotive and industrial, will remain strong next year. And the gap between the capacity installed or planned capacity and the demand will still exist. Of course, not at the level of 2021 because everybody has been taken by surprise, will improve but will not resume completely. And the customer behavior from the embed electronics today is to ask to semiconductor company if they can support '23 and '24, not because they want to double order or they want to build stock and so on and so forth, but simply because they will invest a huge amount of money to make their own transformation. And it is important for the car industry, for the industrial verticals to make the sanity check that all the investment they will do by themselves will be supported by the supply chain. So this is what we see overall from the market today. I think it is consistent with the fact that recently WSTS increased the market we serve growth perspective. Because basically, this year, the market should grow by 26% and next year by 10%. This is the last data point we have. And this is consistent with the discussion we have with our customer. And this is consistent with various KPI we can monitor across the value chain in terms of inventory and in terms of bookings, in terms of, let's say, planning horizon for the order bookings. I confirm that for ST taking into account our market exposure, our ongoing customer programs on customs, then the capacity we have set up in H2 this year and we will set up in H1 next year, we should be able to grow above the market we serve. And in terms of color, definitively, what I can confirm is that for sure, our ADG group, so automotive and power discrete group for sure, will contribute well above the average growth of the company next year. I can confirm that the microcontroller and digital as well will contribute above the average of the company. The IMS, okay, will grow definitively, but slightly below the average of the company. So this is the dynamic we say. And because steel gap will exist between our capacity and the demand, certainly, our top 20 customers will grow above the average of the company. The other OEM we said will grow at the average of the company and the distribution channel will grow, but below the average of the company. So this is the overall picture and color I can share with you for next year.

Very clear. Just on the distribution channel point then, it's growing below the corporate average. Obviously, everything is growing very quickly in this way. But how do you see sort of distribution channel inventory as a sort of as a specific point? And then just a comment on lead times as well. Would be interesting before we sort of close out, to the longer term.

Distribution channel inventory, and Lorenzo will comment as well, the inventory in all the product lines are still very, very lean clearly. So I mean we don't see absolutely, for the time being, some, let's say, inventory replenishment at a normal level, still well below the normal level. And of course, there is clearly no other inventory buildup. I guess everybody are monitoring very, very well what is happening around the distributor and the retailer and what is going behind. Monitor very, very well and very, very closely spot market, where you can see some PC suddenly available at a very high price. So all these things are under control. Then, again, we -- you know that ST has an important partnership with distributor. This is what we call the mass market. We have developed a complete offer and an ecosystem between our general purpose MCU, our general purpose analog, our MEMS, our power devices. More than, again, it is clear and I confirm that next year, again, we will have a gap between the demand, and because the transformation of the automotive and steel and our capacity. And for sure, in the allocation process overall, as a matter of outcome, the top 20 customers will go above because we will try to serve the demand. Then we have managed the other OEM with some specific programs. And then we manage the distribution. And we try to manage to keep the relationship with all the customers, whatever they are, for the future and we try to protect them. But for sure, we cannot serve them exactly as the same, let's say, coverage.

I'm not sure if, Lorenzo, you want to take a comment anything on long lead times?

Lead time is still very stretched. When before, let's say, Jean-Marc was commenting the dynamic that we see next year,in term of growth and only it was expanding about the groups, it was expanding about, let's say, the kind of customer. Yes, we need to keep in mind that, actually, if we take, for instance, the case of our microcontroller or IMS, this group are growing less than the average. It's definitely not driven by the demand. It is driven by the capacity. So here is really a situation in which still we have a constraint in terms of capacity, not in term of demand. So at the end, of course, we had to reallocate the available capacity to protect customer and distribution and so on. The situation that we see is still a situation with a very strong demand substantially across all our markets that we serve. And in our capacity, notwithstanding the investment that we have in place this year and also next year, we will not be able to meet the level of demand that we see in front of us.

And so I think this is a unique point where we have an investor question saying -- asking, given the constraints you're talking about, what is the revenue capacity for the company through '22 and '23 on a current basis?

The dual account...

No. You mean the capacity for automotive or the capacity overall?

I think the question is referring to overall. I mean free to get into detail.

Overall capacity in this -- in terms of revenue.

We are planning for 2022 capacity which will enable us to grow above the market we sell. So as a market we sell is expecting to grow by 10%, of course, it will be a double-digit growth. And our capacity -- and on supply chain because, again, we have to check also our own supply chain in terms of materials, in terms of specialty gases, chemicals and really the order confirmation of our equipment supplier. So our capacity will be capable to support it. It is clear that we are investing our capacity on wafer fab 12-inch and wafer fab power electronics and power analog. We are not investing in, let's say, legacy technology 18-inch and 6-inch because again, it is not economically sustainable. Good to know that also next year, our foundry partner will grow at a similar path our wafer fab, okay. This year, we suffer much in H2, H1 -- surpass than ourselves. Then this is for the wafer fab 2022. Then for 2023, clearly, we will prepare in 2022 an important wafer fab, which is -- I got 300-millimeter because next year, we will set up what we call the first industrialization manufacturing line in order to start, to qualify the technology, which will be the first technology to be produced in 2023 from Agrate. And this will call, of course, for, let's say, a adequate CapEx . In parallel, okay, we have also decided and we are working on further expansion of coal, which is expansion of the 3, that we will decide and we have planned to saturate at a certain level next year, end of next year as well to contribute to 2023 revenue increase. But then, of course, there is power electronics. And there is an advanced power driver, what we call the smart power, the power analog, where because of the strong demand of automotive and industrial market. Here, we are investing both on the most advanced 8-inch we have and, in certain extent, in 12-inch. So this is a view for the wafer fab. Again, it will enable the company to, let's say, grow faster than the market next year, and it will enable the company to continue to grow above the market we serve in 2023. Well, we are confident to do it because compared to the capacity we planned in terms of revenue next year, the backlog we have represent approximately 1.5 years of the capacity we are selling for next year. And this is something, we are managing. On assembly and test here, I have 2 things, that we will balance our CapEx between internal and external, and the external weight of our production starting '22 will increase. Today, we are in the range for assembly and test between 35% external, 65% internal. By the end of 2022, we'll grow more. We will be above in external, okay? I guess we'll go 40%, 45% and we'll remain 55% internal. And investing, okay, really on the property packages and power and test. Again, this assembly plan will enable our capability to grow faster than the market we sell both in 2022 and 2023.

Very clear. Sorry, I have to ask the cheeky question. In terms of constraints on investment, One of your peers have sort of notably talked about the fact that, obviously, foundry is really moving away from very trailing-edge technologies, and they found themselves needing to invest on much older nodes, 130 nanometers plus. So just curious about whether you're seeing a similar push that foundry doesn't want to adopt some of those nodes and you will have to devote increasing amount of CapEx going forward to some of those solutions?

No, Clearly, the main difference between ST and the usual fab-less foundry model that ST an invested steadily in propriety technology, fully matching with the market we address. And here, I have spoken about analog, mixing, RF and AMOLED flash technology, okay, which is, of course, a big bulk of our capacity. So means we have invested mainly in -- either in advanced 8-inch at 110 nanometer. And then we have invested in 12-inch from 19-nanometer to 28 nanometer, which is really the bulk, the big bulk of the automotive demand and of, let's say, the industrial demand. Unfortunately the foundry, general purpose foundry, they have invested heavily on most advanced technology. So a few years ago, 16 FinFET and 10 FinFET and 7 and low 5, and they have simply reworked the investment they have done 15 years ago to support the mobile phone industry and PC industry to address electronics. But they didn't invest purposely to face the transformation I shared a few minutes ago. And this also one explanation of the reason why there is no shortage in 2021 is because many, many players are fab light. They have invested up to 8-inch. They have invested on power electronics, but never on 12-inch, okay, or model flash or mix signal, except TI, except ST, as an example. Now is a foundry for sure, they're are blocked to invest purposely. I think you have seen the announcement in Japan. It is not on 5-nanometer. It is on 28-nanometer, 14-nanometer. But this is what we are seeing? But ST, we will have benefits because, again, I repeat next year, our foundry partners will increase their volume to support us. And believe me, it is not on 5-nanometer, it is a 19-nanometer and 14-nanometer. So yes, the foundry has to react. But again, to build a fab, you need basically 24 months, and to set up the fab at the maximum capacity, you need an additional 24 months. So it will take time to bring breakthrough in terms of capacity, not before 2024 or 2025.

Turning to margins, Lorenzo, A common question that's repeating from investors is what is the visibility and confidence that the underlying gross margin improves into 2022 as, obviously, you're seeing some favorable near-term effects that you flagged on pricing? But then you talked about cost inflation coming through. So can you talk about the degree of confidence and what building the bridge year-on-year.

In terms of evolution of our gross margin from this year moving next year and then maybe moving forward, for sure, considering the situation of the market, considering the negotiation that we have now with many OEMs about pricing, what I can say is that, definitely, we still are in a very positive environment in terms of pricing. We were talking before about the situation in distribution that is very, very lean in terms of inventory, the parts. We are talking about automotive in which now the real focus of our customers to get the parts. And so there is also willingness substantially to contribute to the investment that we are doing. So in terms of pricing, we do expect next year, being a year in which there is a positive contribution of this, of the dynamic of the pricing on our profitability. On top of that, as a positive impact, there will be the fact that now all our facts, all our plants are working at full steam. So it means that the level of efficiency is quite high there is still room for productivity improvement. And this definitely will be accretive to our profitability coming in the year 2022. It's true that on the other side, we have the negative impact of the inflation, means that starting from electricity moving to materials, gases, chemicals frame, substrate. Of course, there is a negative impact. There are a price increase. We were, in 2021, protected from agreements from long-term agreements. Some of them will also, let's say, for -- in 2022, but many of them will be progressively be renegotiated because they are, let's say, expiring. So we do expect this negative impact. All in all, anyway, when I look at the average gross margin in this year, in 2021, that will be in the range of 41% the midpoint of our gross margin of Q4. And I factor in all these ingredients that I was telling you for in 2022. At the end, I still see progression in our gross margin in the average of the year. Of course, it's a progression that is a different pace in respect to this year. This year, of course, we increased significantly our gross margin from 39% to 43% if we look Q1, Q4. Next year, this progression will be not at this pace, but there will be still progression in our gross margin. Moving forward, what it will be important in order, let's say, to continue to progress on this path in terms of gross margin and overall profitability will be the fact that we will move more and more of that reach. Today, the investment that we are doing in 18-inch in term of productivity, in terms of being accretive on the gross margin are not. Because today, most of the equipment that you buy are 18-inch or 12-inch downgraded. So means that it cost more or less like a 12-inch, but with a productivity of 18-inch or 800-millimeter. So actually, let's say, the next step in order to continue to improve our profitability, it will be to move a more significant portion of our production towards the, let's say, the 300-millimeter, towards the 12-inch. And this is the reason why, of course, we are not only -- of course, to serve the demand. But to serve the demand moving, let's say, the capacity increase of on, call it, 300. So adding capacity there in a modular way. And accelerating as much as we can and the ramp-up of our 300-millimeter facilities in of Italy, the Agrate one. That next year will we think at the end of the year started to contribute very marginally to our capacity. But In the course of 2023, a more significant way.

Just related to that, we have an investor question specifically on the ADG business. Can you explain sort of the gap between APG and the other businesses? And specifically, when should you expect, given what you're describing about the ramp-up of 300-millimeter for the average margin of ADG, to catch up to corporate average?

ADG, yes, definitely, when I look at ADG operating margin and I compare with the other 2 groups, there is a significant gap. I think here, we do expect that to recover quite rapidly this gap for 2 main reasons, I would say. On one side, we see ADG will be one of the groups that will enjoy more, let's say, price improvement in terms of price to our customers next year. Now we are in the phase of renegotiation of the contract. As I was saying, let's say, definitely, there is understanding from our customer that this transformation that we were experiencing in automotive in need somehow be, in some way, they need to participate to the effort, to investment CapEx that we are doing. So actually, we see definitely for ADG, a positive environment in terms of pricing. ADG will also benefit from what I was saying before, let's say, improvement in terms of manufacturing efficiency. This year for APG was a difficult year, especially in Q3, we were impacted by the pandemic in the back end. Of course, the main impact was on the top line and not only -- also, of course, it was creating some inefficiency that was hitting this group. This will be something that we will not be experience anymore. We think that, at least in our projection moving forward in 2022. So we will see progressively for ADG significantly reducing the gap in terms of profitability between ADG and the other 2 groups.

Staying on the automotive topic. I think, Jean-Marc, in the past, you commented that what is happening today is not a shortage of semis, but a lack of planning and anticipation. So in the light of that, today, as we discussed this, are you seeing better visibility from those OEMs? And are they giving you firmer orders and they're willing to accept that?

No, it is clear that all the key actor of the value chain of these verticals, whatever they are, have not anticipated that, at the same time, we will have the accumulation of -- acceleration of the major transformation, so smart mobility, faster recovery of the economy and demand for light vehicles. But also, let's say, for trucks, okay, for other kind of vehicles. And then that the supply chain from between car and Tier 1 was not adequate to face such fast recovery. This is something we discuss widely among ourselves on a day-to-day basis on top of to manage the shortage. Now clearly we are working with OEM, Tier 1s, for 2022 to see each of us can fulfill at the best the demand, the real demand, without any inflation on inventory or this kind of stuff and to enable positively the car industry. Importantly something we have never seen as a semiconductor company, okay? Now we are already discussing about '23 and '24. And why? Because of the transformation because, okay, it's well known now that this industry will make for the next 3, 4 years, a transformation which has never done since the 40, okay? And clearly, it will call for major CapEx, major R&D, engineering effort, sometimes restructuring, which will not be easy to manage, and will call for important financial resources. And the duty of all the actor is to check that the value chain will be capable to supply it. So this is something we have never seen and we are seeing now. So for sure, okay, we have taken a lesson about that. However, the solution is not so easy because, clearly, we are in a transition phase. Means we will have a mix of demand between a new device, silicon carbide MOSFET, let's say, new applications, battery management system, asking for more MCUs, more power driver, more, let's say, power electronics. We'll see an acceleration of the headers, acceleration change of the architecture of the car, moving from fragmented MCU to domain zone and so on and so forth. But in parallel, the pure legacy, so door control, body control, brake, air bags, lighting, this kind of stuff, okay, is still there and has not yet switched on more advanced technology. So we will have a situation where we will have to manage together a huge transformation asking for all the value chain important investment in terms of product technology and new capability, but still a demand on the legacy. And this is what will make the next 2 years challenging, definitively.

And so related to that, I guess one obvious areas, are you seeing an increased visibility on silicon carbide specifically? Obviously, you brought forward the $1 billion revenue target to 2024. But just more broadly, are the OEMs giving you more visibility? Should we -- are there other milestones that we should expect within the investment community that, okay, we're going to see a lot more announcements in 2022 for those design-ins that will obviously take 2 or 3 years but come middle of those decades? And then related to that, also on silicon carbide, the fact that JTAT -- GTAT, excuse me, GTAT was acquired, does that redouble your sort of emphasis and efforts on the vertical integration?

Now silicon carbide, you know that we enter in this, let's say, most MOSFET application for inverter, but also in industrial application. Basically the first, more clearly, we have communicated consistently frequently about the design win and our perspective in terms of revenue, in terms of sustainable market share. And this up to, let's say, very recently, our positioning was, okay, $1 billion corresponding approximately 30% market share and enabled by, let's say, well above 50 programs, okay, 50, 70 programs. As a matter of implication of the post COVID has been an acceleration definitively of the electromobility. Now you see as a guest, you see all the advertisement, you see the success of Tesla, you see the success of the Chinese carmaker, you see many introduction of electrical car platforms are on the market. Of course, this has accelerated the demand for silicon carbide. And as we are capable to support both our legacy customer now and the new platform, we have decided -- because we have the capability to invest to support this business to pull in our objective by 1 year, full year, and we really will do $1 billion revenue full year 2024. Means we will exit 2023 with a rate, approximately at this level. And clearly, it is linked to the acceleration of the electrification. In parallel, okay, the appetite for the silicon carbide is continuously increasing because it is a clear competitive advantage in terms of cost of ownership. You know that on the electrical car, you can optimize the cooling system, you can optimize the inverter footprint. At the end, you can also optimize the performance and the mileage of the car. Yes, the solution by itself as a device is still, let's say, more expensive than AGBT, but the perspective of cost reduction are quite, let's say, important. We can work on the modules, we can work on the wafer side when we will be 8-inch. You can work on the architecture of the device, you can work on the ingot yield optimization with, let's say, some cut technology of the wafer more sophisticated. So there is also, let's say, an appetite increasing on the silicon carbide. And that's the reason why now we are communicating more than 80 programs awarded and going on, which make us comfortable that we will achieve our target of $1 billion by 2024, and we will sustain 30% market share.

Very clear. And then just a final question. I was tied to investor questions. Given all these growth factors,and where valuations are today, are there any areas of the business that you would like to strengthen via any M&A? Or how do you really see your existing organic opportunities versus those external one?

Well, at the end, I think what is the driver? The driver is to be convinced the way to increase steadily and continuously the fundamental value of ST. Clearly, facing the 2 verticals where strategically ST claim, we want to lead and we want to be broad range facing this major transformation. We do believe that leveraging our technology IP portfolio, product portfolio, providing differentiation to our customers we can continue to grow organically, creating value for ST and for our shareholders. That's the reason why, at this stage, we do believe that organic growth -- of course, with some fast bolt-on acquisition as we have done last year and the year before and the year before to expand, to accelerate, is a strategy which can continue to create value for our shareholders. We do not want to exclude completely some bigger acquisition in the future. I think, first because it is our duty to continuously monitor the competitive landscape, and to detect what could be interesting for ST. It could be also a way to make a larger acquisition to acquire talent because you know that design capability, IP design or capability, application field engineer, application engineer are talent that any company needs, is not totally out of our radar screen. But from value creation, we do believe that we can continue to apply this strategy in our current strategic plan that we will complete very soon.

Very clear. And thank you both for your time today. So please join me, and thank you, Jean-Marc and Lorenzo for their time today, and thank you to all the investors who've dialed in as well. Goodbye.

Thank you. Thank you.

Thank you.

Thank you very much. Bye.

Bye.