GlobalFoundries May Continue Its Decline Into eFY25 (NASDAQ:GFS)

GlobalFoundries Inc. (NASDAQ:GFS) is finding itself in a challenging position as customers are going through inventory destocking while the firm runs at 70% capacity. The firm is further placing itself at risk of overbuilding capacity with a new foundry that will be paid in part through awards granted through the CHIPS Act and the New York State Green Chips Program. I believe GlobalFoundries will face growth challenges throughout the next two years as the macroeconomic environment deteriorates, leading to over-capacity paired with reduced customer volumes. I rate GFS shares with a SELL recommendation with a price target of $42.24/share at 11.13x eFY25 EV/aEBITDA.

GlobalFoundries Operations

Many of the analysts alluded to GlobalFoundries stepping on its own feet with building out their capacity. With 70% utilization and diversification across their global foundry footprint, this question does come into play as concerns arise with customers’ heightened inventory levels. This has left GlobalFoundries with a heightened level of days inventory on their books, which may take the duration of eFY24 to cycle out. This has also raised some concerns with customer LTAs as GlobalFoundries was faced with volumes adjustments across various industry segments, which I believe may result in lower volumes going through eFY24. Management did note that the firm has $20b in LTAs for various duration agreements, depending on the product life cycle.

Management voiced stronger growth in the smart handheld devices segment for eFY24 when compared to semiconductor designers; though this is a relatively optimistic outlook considering the relatively flat expectations for the segment throughout eFY24 by firms like Qualcomm (QCOM) or Micron Technology (MU). Memory and storage chipmaker Micro Technology suggested eFY24 sales will likely be replacement sales rather than sales growth, as consumers will not necessarily be seeking to upgrade to the latest AI-enabled devices. The same goes for the next generation of AI-enabled PCs and workstations, in which Micron’s management anticipates a relatively flat market with limited interest in the next generation of devices. Even if sales volumes were to remain relatively flat for smartphone sales, there may be some upside potential as more content per device will be sold on the latest generation of AI-enabled smartphones. Smart mobile devices account for 44% of total revenue and have been in a steady decline for the last 5 quarters. Management does anticipate that the bottom is nearing; however, I believe there are more factors at play that will keep devices flat for the duration of eFY24 and potentially into eFY25.

One of the major headwinds faced in this segment, along with other segments, is customer inventory levels. Management voiced that customers are currently going through a destocking phase, which is in part to blame for the decline in revenue. Despite inventories being drawn down, customers are also renegotiating their long-term sales agreements and pulling down volumes, which may suggest there are long-term effects at play that may result in a continuation of sales decline. I believe the elevated inflation rate will play a larger role in the decision-making process for end customers when it comes to upgrading their smart mobile devices. Though replacements may be necessary for lost and broken devices as well as higher income earners upgrading just to upgrade, I do not anticipate a mass migration to the latest generation of AI-enabled smartphones as consumers are faced with a higher day-to-day cost of living.

As for the automotive segment, I believe there may be similar headwinds as a result of the higher cost of living. In addition to this, insurance premiums have skyrocketed in the last year, which, I believe, is in part the result of higher costs to ensure an electric vehicle.

Combining insurance premiums with the elevated cost of borrowing, purchasing a vehicle is just overall more expensive.

The year-to-year change in consumer loans for vehicles may shed some light into consumers putting off purchasing their next vehicles as loans mature. This could also indicate lower sales volumes for vehicles, higher down payments, or consumers opting to purchase lower-cost models. Whichever may be the case, I believe that this indicates a certain degree of decline for automotive chips, as lower-cost models may not require the same amount of chip content as the more sophisticated models.

Home & Industrial IoT may experience the same fate as devices and autos as consumer discretionary spending is balanced with a higher cost of day-to-day living.

Inventories appear to be contracting at a slower pace, which may be a good sign for GlobalFoundries. Despite this slowdown, new orders for computers and electronic products remain in contractionary territory as well, indicating that there may be a deeper challenge faced.

Orders have started to rebound, but inventory levels remain high enough for no impact on our supplier orders. It will take a few more strong months before supplier orders are reactivated or increased.

ISM-PMI: [Computers & Electronic Products].

This is also a signal that there may be a rebound on the horizon if inventories continue to be drawn down. Though this may broadly be the case, there still remains the challenge with GlobalFoundries’s LTAs being reeled in on a volume basis. These contract changes are either related to near-term headwinds for the customers or are long-term forecasts for fewer volumes needed. This could very well place GlobalFoundries in a tight position as the firm invests in their new foundry, paid in part by a $1.5b award through the CHIPS Act and an additional $600mm proposed by New York State under the Green Chips Program. Given that GlobalFoundries is running at 70% capacity, the firm may be at risk of overbuilding capacity and risking economies of scope.

Management mentioned in their q1’24 earnings call that the firm is diversifying their foundries to localize chip production across all regional verticals. I found this fascinating, as it may create some marginal headwinds for the firm as each foundry will no longer specialize in a series of chips but, rather, spread its talent across multiple nodes to ensure regional capacity. Though I do believe that this will reduce supply chain risk, I also expect that this method of operations may add some marginal risk to operations as additional machinery may be needed to produce different nodes of semiconductors.

Given the broader theme of inventory destocking occurring across various verticals for GlobalFoundries, I anticipate a modest decline at the top-line paired with modest margin contraction going through eFY24 and into eFY25. The ISM-PMI manufacturing index indicated for the month of May that backlogs for computer and electronic products remained declining, adding pressure to future production even as inventories are reduced. For the most part, I anticipate a challenging eFY24-25 for GlobalFoundries given the macroeconomic outlook.

Despite this negative outlook, there may be some bright spots for the firm, especially in the automotive industry. As newer vehicles become more sophisticated, more chips will be required. Even if a flat new vehicle sales environment, more content per vehicle can be a driving factor for growth for GlobalFoundries. I also anticipate a rebound in datacom towards the latter end of e2h24 or at the beginning of eFY25, as network infrastructure will require higher rates to cater to AI infrastructure. This may provide some tailwinds for GlobalFoundries in their communications segment.

Valuation & Shareholder Value

GFS currently trades at 10.21x EV/aEBITDA, the lower end of their historical range. Given my financial forecast for the firm, I anticipate further decline in the share price within their historical trading range. Given the headwinds faced across most segments, I provide GFS shares a SELL recommendation with a price target of $42.24/share at 11.13x eFY25 EV/aEBITDA. This valuation was derived by using a probability profile of risk scenarios based on historical trading multiples.

Comparing GFS to its peers, the stock trades significantly higher than its nearest competitor, United Microelectronics Corp. (UMC), when considering market cap. Using an average of Taiwan Semiconductor (TSM) and UMC, we can come up with a similar trading multiple as seen in my independent valuation table above.

GlobalFoundries’s shares are primarily concentrated in Mubadala Investment Company, with 95.84% ownership. GlobalFoundries recently announced a secondary offering of $950mm shares to be sold by Mubadala with an option to sell upwards of $112.5mm shares on May 22, 2024. This shelf offering includes a $200mm share repurchase of these shares, which should limit the dilution as a result of the secondary offering.