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4 “Picks and Shovels”-Type Semiconductor Companies: Lam Research (LRCX), ASML Holding NV (ASML), Micro-Mechanics (5DD), UMS Holdings (558)

There’s been a global chip shortage due to COVID-19 that may last into 2022 and even 2023.

In a gold rush, be the guy selling “picks and shovels”. You’re not going to be the one who finds any gold but regardless of who finds or doesn’t find gold, you’re going to make money.

Similarly, amidst the current global semiconductor shortage, be the guy (or invest in the guy) selling tools to make semiconductors.

Experts claim that the global supply chain, most importantly Taiwan’s TSMC, has always been open to an exogenous shock. It took COVID-19 to rear its ugly head to prove the point. In response, the world’s dominant chip-making companies and governments have pledged to ramp up chip-making capabilities:

  • Taiwan Semiconductor (TSMC), the largest semiconductor manufacturer plans to spend $100 billion over the next three years alone to increase production capacity.
  • SK Hynix, one of Korea’s largest semiconductor manufacturing companies is set to spend over $109 billion.
  • The Biden administration is calling for a $50 billion build out of the semiconductor supply chain.
  • Intel has announced $20 billion of capital spending to ramp up capacity.

In this edition of our 4 Stocks This Week column, we look at four semiconductor “picks and shovels” type companies that stand to directly benefit from the world’s vastly increased spending within the sector.

#1 Lam Research (NASDAQ: LRCX)

Based in America, Lam’s customer base includes a majority of the world’s leading semiconductor manufacturers.

In 2020, customers accounting for greater than 10% of total revenues included Micron Technology, Inc. (NASDAQ: MU), Samsung Electronics Company, Ltd. (OTC: SSNLF), SK Hynix Inc. (OTC: HXSCF), and Taiwan Semiconductor Manufacturing Company (NYSE: TSM). Other major customers included Intel Corporation (NASDAQ: INTC) and Toshiba Memory Holding Corporation.

34% of 2020’s revenue for Lam Research was based on “servicing” with the rest coming from sales of manufacturing systems.

Source: Lam Research Annual Report 2019

To put it simply, Lam Research first sells you the system and then sells you the services required to keep the system running at tip top conditions.

This is a highly attractive business for two reasons:

  1. Switching costs. It costs hundreds of millions of dollars to buy manufacturing equipment. Earning a return on that spending requires years of operations. Years of operations entails years of servicing.
  2. Servicing is required as long as the machines you bought are in operation. As they will likely remain in operation for some time in order for you to earn returns on buying it, you will likely require servicing for some time. This means recurring revenues. Recurring revenues are great because they provide a buffer in bad times and allow for greater earnings visibility. This confers greater valuations.

More importantly, the installed base of semiconductor manufacturing is about to get much larger as the world rapidly decentralises the global chip supply chain. With a much larger base of semiconductors come a much larger need for servicing. Both things come in tandem, and Lam Research stands to reap the benefits of both.

Lam Research currently trades at $613 per share and about 30x earnings. Shares of Lam Research are up 30.1% year to date.

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Have you ever wondered how chips in our computers and phones get smaller and smaller? The answer is Extreme Ultraviolet (EUV) Photolithography machines.

ASML is the only company in the world that makes EUV Photolithography machines. It’s machines shoot a piece of molten tin with a laser in a vacuum to create plasma, which radiates EUV light with a wavelength of 13.5 nanometers. This must be performed in a vacuum so that the light is not absorbed by surrounding matter. Twenty mirrors are then used to aim and focus the EUV light on the silicon to etch it.

To generate enough light, ASML’s machines must fire the molten tin 50,000 times per second to produce enough plasma. ASML’s machines cost over $200 million each and require 4 fully loaded 747s to transport.

Of course, the machines are proprietary and patented – which means ASML has a monopoly on chip fabrication technology for the whole world.

With the average amount of semiconductor chips per household set to grow enormously in our world of rising connectivity, ASML is another company that may benefit.

Twenty years ago, we could on average find one semiconductor chip per household – sitting on our parent’s pentium processor, which also happened to be the only computer in our home at the time. Today, each household averages 1-2 semiconductors per person at a minimum (phone, personal laptop/computer). And that’s just within the household. Cars, trucks, railways, personal mobility devices, and even our pets may all one day have a chip if they don’t already.

While it’s not a “sexy” business, don’t dismiss ASML just because of it. We are all going to be needing its enormous machines producing “sexy” tech for the foreseeable future.

ASML currently trades at $641, and about 63x earnings. Shares of ASML are up 32.7% year to date.

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#3 Micro-Mechanics (Holdings) Ltd (SGX: 5DD)

According to its annual report: “Micro-Mechanics designs, manufactures and markets high precision parts and tools used in process-critical applications for the wafer-fabrication and assembly processes of the semiconductor industry. Today, MicroMechanics serves a worldwide base of customers from five manufacturing facilities located in Singapore, Malaysia, China, the Philippines and the USA, and a direct sales presence in Taiwan and Europe.”

Just as chips need specific machines to build them and companies to service them, they also need specific services to test them and ensure their reliability.

Micro-mechanics fulfills that role. It currently provides the necessary tools for die-attach, wire bonding, and encapsulation testing. This might seem to be a low-value business, but the opposite is true.

Considering the fact that clients of Micro-Mechanics has sunk hundreds of millions, if not billions of dollars into their equipment, they would want to know that (1) critical though smaller parts of the production line works and (2) that all products coming out of their manufacturing processes are adequately tested and certified to prevent mass recalls and losing potential re-contracting/business in the future.

All this means Micro-Mechanics has a steady supply of demand to service as a small but key part of the value chain for semiconductors.

Micro-Mechanics currently trades at $3.33 a share and has a dividend yield of 3.3%. Shares of Micro-Mechanics are up 19% year to date.

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#4 UMS Holdings (SGX: 558)

UMS specialises in high precision front-end semiconductor components among other processes meant for semiconductors. UMS also caters to other industries, including electronics, machine tools, aerospace and oil/gas industries.

Applied Materials (NASDAQ: AMAT) is a key client and was responsible for close to 90% of 2020 revenues. AMAT has also apparently been a client since 1999.

This is a good thing – higher spending from their customers mostly means greater revenues for UMS holdings.  Also note, AMAT itself benefits from TSMC’s increased spending which has the potential flow down to UMS benefits-wise.

Currently, the large and ongoing global chip shortage should induce a stepwise large increase in spending. UMS stands to benefit from this decentralisation and increased production output.

UMS trades at $1.36 and has a dividend yield of 2.57%. Shares of UMS Holdings are up 18% year to date.

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