Best Semiconductor Gem!

Semiconductor stocks had a superb run in the last fwe years driven by shortage of chips and then the current A.I. craze. The following chart from finchat.io showed that investing in the SOXX ETF would have delivered over 200% return or CAGR of 25%.

Today, we are going to discuss a related idea with potentially more upside given that the stock has corrected more than 45% but the big tailwind story hasn't really changed. But first let's look at the financials:

Simple Financials (Mar 25 estimate)

• Sales: 2.3trn and EBITDA: 700bn
• OP: 600bn and NI: 500bn
• Market Cap: 10trn
• FCF: 450bn and Net Cash: 500bn 

Financial Ratios

• PBR 5.3x and ROE: 26%
• EV/EBITDA: 11.3x
• PER:16.7x
• FCF yield: 5%, Dividend Yield: 1.8% 

Isn't it amazing to be able to buy such a high-octane semiconductor play at such valuations? Hence the tagline that this could be the best semiconductor gem! As an experiment, we shall not reveal the name today. Interested readers could try to guess and go onto substack to find out. But for convenience, let's call this company T. 

1. Fundamentals

The following is the investment thesis for T:

T is the one of the top players in the semiconductor industry with high market share in certain core products. It stands to benefit from the continuous growth of the semiconductor market and is especially geared to capex growth in its home country. At current valuation, investors can enjoy 5% FCF yield and almost 2% dividend with 80% technical upside if market sentiments improve quickly.

The chart below shows that the market is estimated to double from USD500bn to USD1trn by 2030. As one of the top companies in the value chain, T will grow in tandem with the market and current share price correction provides the opportunity to buy cheap and gain good exposure today!

The manufacturing of semiconductors is also highly complex and in various parts of the value chain only the best of the best survived. The number of players have shrunk to just 1-3 in most segments. In actual high end cutting edge production, there is only Intel, Samsung and TSMC and in the field of lithography, there is only one player left - ASML.

Positives

High and growing market share: the production of semiconductors requires many types of equipment which are manufactured by T. It would take up too much space to describe all of them. The following paragraph describes the opportunity well:

T commands a share of more than 80% of the coater/developer market and more than 60% of the thermal processing system market*, but has less than a 30% share of the etch system market and less than 20% of the cleaning system market. Etch systems and cleaning systems are both used in key semiconductor production processes and therefore their markets offer strong growth prospects going forward. 

Increasing dominance in servicing: as the largest player in the field, T also has a huge installed base of past equipment globally and only T can service its own equipment. This has led to the growth of its servicing business (currently 20-30% of revenue) and at the same time strengthen its business moat as customers are unable to switch to competitors while new entrants are also not able to gain market share.

Risks

However, the thesis is not without risk. T has significant exposure to China and stands to lose this portion of its business should the trade and technology war between US and China exacerbate. The mitigating factor is that there is no other provider and China will find a way to still buy from T via different routes not unlike how arms dealer can find ways to sell weapons around embargoes.

The rest of the post can be found on substack.