This Upgraded Stock Is a Buy for the Long Term

We recently upgraded NXP Semiconductors’ NXPI economic moat rating to wide. This chipmaker has a strong position in the automotive, industrial, mobile, and communications infrastructure markets. We think its long-term prospects are bright—and its stock looks about 20% undervalued today. In fact, NXP claims a spot on Morningstar’s quarterly list of 10 Best Growth Stocks to Buy for the Long Term.

NXP is one of the largest suppliers of semiconductors for the automotive market and a significant player in the analog and mixed-signal chip markets generally. It is well positioned to benefit from safer, greener, smarter cars in the years ahead; we’re optimistic about its development of products used in active safety systems. NXP’s prospects are also bright in its industrial and Internet of Things segment. In communications infrastructure, NXP should remain a key supplier of power amplifiers into 5G wireless infrastructure equipment. Finally, we expect its mobile wallet solutions will remain the industry’s gold standard and the backbone of mobile payment technologies offered by Apple, Google, and others.

Key Morningstar Metrics for NXP

• Fair Value Estimate: $320
• Star Rating: 4 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: Medium

Economic Moat Rating

We believe that NXP’s wide economic moat comes from intangible assets around proprietary analog and mixed-signal chip design and manufacturing expertise, as well as switching costs that make it difficult to swap out these chips for competing offerings once they are designed into a given electronic device. We believe NXP’s automotive and industrial chip businesses, which make up most of its revenue, are wide-moat segments. The consumer Internet of Things business is perhaps less moaty, as design cycles might be quicker. NXP is a clear leader in near-field communication for mobile payments, but given the faster technological cycles of smartphones, it’s possible that it might benefit from switching costs a little bit less in this business. Nonetheless, we don’t think these risks will weigh on NXP’s ability to generate excess returns on capital over the next decade or beyond.

Read more about NXP’s moat rating.

Fair Value Estimate for NXP Stock

Our fair value estimate implies a 2024 adjusted price/earnings ratio of 23 times and a 5% free cash flow yield. Inventory digestion and slower growth than anticipated in electric vehicle sales should cause NXP’s revenue in 2024 to be flattish. Thereafter, we anticipate a recovery in demand across all end markets, with 8% growth in 2025 and 11% in 2026. We model 9% midcycle growth for the long term. NXP is likely to maintain a 58% adjusted gross margin in 2024. Thereafter, we think the company can achieve modest expansion to 60% by 2028. We model a 35% adjusted operating margin in 2024 and anticipate subsequent expansion to 38.5% in 2028.

Read more about NXP’s fair value estimate.

Risk and Uncertainty

While a good portion of NXP’s automotive growth is tied to rising chip content per car, it would be difficult for the company to grow during a severe downturn in light-vehicle sales. The communications infrastructure end market is notoriously lumpy, depending on the timing of network buildouts across the globe. Industrial and IoT chip sales are also often tied to the health of macroeconomies. In mobile, NXP’s prospects depend in part on premium smartphone unit sales. The US government’s effective ban of Huawei emerged as a headwind for NXP and its peers, so geopolitical tensions may matter more in the chip industry in the years ahead. However, since NXP is based in the Netherlands, it could be a beneficiary if China were to avoid using US-based microcontroller units in the future.

Read more about NXP’s risk and uncertainty.

NXP Bulls Say

• NXP is an automotive chip leader with reliable products and strong customer relationships. This should give it an edge in newer technologies, such as 77-gigahertz radar and battery management systems.
• The company should generate healthy margin expansion as it grows across a variety of end markets and has exited some commoditylike businesses.
• NXP is the clear leader in mobile wallet solutions, which incorporate NFC and secure element chipsets along with its software. As mobile payment adoption expands worldwide, NXP is poised to benefit.

NXP Bears Say

• The radio frequency power market is increasingly moving to gallium nitride to support 5G, leaving NXP’s portfolio at a potential disadvantage.
• NXP’s dependence on the auto market makes it vulnerable to the cyclical downturns that occur in global light-vehicle sales from time to time.
• China is an important growth market for NXP and counts several national champions as large customers, exposing the company to geopolitical risk.

This article was compiled by Susan Dziubinski and Sylvia Hauser.