The semiconductor industry is on the bleeding edge and full of interesting investment opportunities, from small caps built around a novel product to large caps that make many of the semiconductors found in the devices we all use in our daily lives. In this article, I focus on three companies whose products and services are fundamental to the semiconductor industry and whose businesses have exceptional barriers to entry.
1. Taiwan Semiconductor Corporation (TSM)
Taiwan Semiconductor is the largest independent semiconductor foundry company. The costs of running semiconductor manufacturing plants have become so prohibitive that it's simply not financially viable for small to mid-sized chip design firms to own their own manufacturing plants. So that's where TSMC steps in. The firms that do not own their own manufacturing plants such as Qualcomm (QCOM), Nvidia (NVDA), and Marvell (MRVL) send their designs to TSMC to be built.
TSMC has only a few competitors, including United Microelectronics Corporation (UMC) and Global Foundries. However, TSMC is generally seen as the leader from both a technological standpoint and a capacity standpoint. In fact, the company's major problem is that it simply cannot meet the demand for its latest 28nm process; not a bad problem to have, but the company recently announced an increase in capital expenditures to solve these capacity problems going forward.
From a financial standpoint, the company saw quarterly revenue growth year-over-year of 15.9% and earnings growth of 16.3%. Price to earnings is 16.31, a slight premium to the median tech price-to-earnings of just north of 15, but given the company's critical nature to the semiconductor industry and its strong growth, it does not appear overvalued. Finally, the dividend comes in at $0.40 or a 2.8% yield at current levels.
This company is critical to the future of the semiconductor industry, and as such represents an excellent play on the secular demand increase in semiconductor devices for the long term.
2. ASML Holdings (ASML)
ASML provides photo-lithography tools, critical devices for the manufacture of semiconductors. Many of the advances in manufacturing processes are directly tied to the sophistication of photo-lithography equipment. Both Intel (INTC) and Taiwan Semiconductor made significant direct investments into ASML in order to fund two major technologies: 450mm wafer support and EUV lithography, the significance of which I cover in the article, "Intel's Recent Deal With ASML Was Necessary".
ASML's major competitors are Canon and Nikon, but an examination of the market share trends shows that ASML has emerged as the clear market share leader in lithographic tools with 57.0% in 2011 against Nikon's 27.8% and Canon's 15.2%. Further, with substantial investments from Intel and TSMC, the company will be able to extend its technological lead as the industry moves towards EUV and 450mm wafers.
The stock is currently near the top of its 52-week range of $32.07 - $59.20 at $58.06 as of last close , so I would recommend scaling into the position on pullbacks if you choose to purchase the stock. Intel's purchase price of its 15% stake was roughly $49/share, which should give a pretty margin of safety for any position initiated in the near to medium term.
3. Applied Materials (AMAT)
Applied Materials is the largest semiconductor manufacturing equipment supplier. Interestingly, while the company beat earnings estimates, this came after issuing a revenue warning during the quarter. Further, guidance was tepid, with the company expecting a 25-40% Q/Q drop in revenues (against analyst estimates of a 17% drop) and EPS to come in at between $0.00 - $0.06, significantly below $0.12 consensus.
However, despite gloomy results, the simple fact remains that the company is critical to semiconductor device manufacturing and will continue to be for the foreseeable future. As global semiconductor demand increases and as macro-economic issues subside, the major semiconductor manufacturers will need to continue to expand their capacity and move to more sophisticated process nodes. TSMC, Intel, and Samsung have already publicly announced their intentions to expand capex, and this should only benefit Applied Materials.
It is notable that Applied Materials is also aggressively buying back shares as well as yielding 3% at current levels. This should provide a nice safety cushion for the stock at these levels.