Taiwan Semiconductor Manufacturing (NYSE: TSM), the world's largest chip fabrication company that controls more than half of all advanced chipmaking, said it sees an end to the current chip sales slump by the summer of 2023. As one of the most powerful industrialists on the planet, this company has its finger on the pulse of the global economy.
Its recent commentary on its 2023 outlook reinforces similar calls that other chip companies have been making. It appears that the current downturn, being driven by a steep drop in consumer spending on electronic devices but largely offset by business investments in data centers, will lead to a soft landing for the semiconductor industry. Take heed, because many chip stocks are trading on the cheap. Three Fool.com contributors think Applied Materials (AMAT 1.46%), IPG Photonics (IPGP 3.14%), and Marvell Technology Group (MRVL 1.55%) could soar once the current downturn passes. Here's why.
This cheap equipment manufacturer stock yields exposure to the whole chip industry
Billy Duberstein (Applied Materials): For investors looking for broad, diversified exposure to the semiconductor sector, yes, you could buy a semiconductor-focused exchange-traded fund, but you may have to pay a management fee to do it.
Why not buy Applied Materials instead? Applied Materials is the largest, most diverse semiconductor capital equipment manufacturer in terms of revenue. It serves logic/foundries and memory manufacturers and has a small advanced display business.
As of last quarter, Applied Materials received 71% of equipment sales from the foundry/logic space and 29% from memory manufacturers. Over-indexing to foundry/logic is a good thing, as the memory market is in a severe downturn, which will probably limit equipment sales to memory manufacturers over the next one to two years. On the other hand, logic and foundry chips are supposed to see more consistent and resilient sales. The market currently expects a modest decline in 2023 logic chip sales, after three strong years; however, it's likely the semiconductor sector will resume growth in 2024.
Even if chip sales decline in the near term, there's a good chance investment in chip manufacturing may be more consistent, benefiting Applied Materials. That's because major developed economies have all passed subsidies to build chip capacity on their own shores over the past year, to mitigate the risk of having most of the world's chip manufacturing concentrated in Taiwan. That should enable semi-cap equipment investment to be higher than it otherwise would be.
In addition, Applied Materials also has a less volatile services business, which makes up 28% of revenue. Much (though not all) of that revenue is recurring and tied to the size of Applied's installed base, which grows every year. So, barring a really terrible downturn, that segment should remain stable or grow every year, regardless of annual equipment sales.
The services segment and foundry/logic focus should enable Applied Materials to achieve steadier results in a downturn compared with some other semi-cap players. Once the company is through this downturn, semi-cap equipment sales should resume growth at a higher pace than gross domestic product over the longer term.
Even after a nice recent run in the stock, Applied Materials only trades at 15 times earnings, and should be able to conduct buybacks and raise its dividend even in this soft part of the cycle.
In terms of semi-cap equipment companies, Applied strikes a nice balance between growth, stability, and value. Whenever there's a temporary downturn in the semiconductor cycle, investors should be able to buy Applied on dips with confidence, as it's a great way to play the general growth of semiconductors over the long term.
A laser focus on profitable growth markets
Anders Bylund (IPG Photonics): Fiber laser expert IPG Photonics is a global market leader in its ultra-specific market niche. Its lasers are used in manufacturing, communications, medical treatments, and more. IPG isn't a traditional semiconductor business, but it actually taps into that market from two different angles. Its high-precision diode lasers are made using the same techniques, equipment, and materials you'd use in etching microchips, and semiconductor manufacturing gear is a significant market for this company's lasers.
The company manages a strong product portfolio with a focus on high-value growth markets. As a result, it has the widest profit margin in the industry and a squeaky-clean balance sheet with $1.2 billion in cash and short-term investments and no debt to speak of.
IPG Photonics will benefit from rising interest in battery welding for electric vehicles and laser-based medical systems, as well as an improving economy with more manufacturing on a global scale. The stock price is down more than 30% in 52 weeks. The price drop didn't set it up for door-busting discounts, but IPG Photonics shares are reasonably priced at 21 times trailing earnings.
When those growth catalysts start to unfold in 2023, you'll be glad to have picked up a few shares at a modest price. The stock has a history at fetching earnings multiples in the 30s, leaving plenty of room for price growth based on multiple expansion alone. And that's not even close to the whole IPG Photonics story.
Smaller past bets leading to one big investment on chip secular growth trends
Nicholas Rossolillo (Marvell Technology Group): I've owned shares of Marvell for a number of years now, and each year has offered up plenty of surprises. I began my interest in the company when the U.S.-China trade war started in 2017. Given what was already a cyclical downturn for chip companies, plus the Federal Reserve's last interest-rate increase cycle, Marvell got pummeled. Then of course came the pandemic, and the accompanying explosion in sales for all things digital.
Along the way, Marvell has been on an aggressive acquisition streak: It bought ARM-based network processor designer Cavium in 2018 for $6 billion in cash and stock, multi-gig ethernet connectivity company Aquantia in 2019 for $425 million cash, the former application-specific circuit designer unit from GlobalFoundries called Avera Semi in 2019 for $650 million cash, optical networking component designer Inphi in 2021 for $10 billion cash and stock, and data center networking company Innovium in 2021 for $955 million in stock.
The rationale behind this messy-looking takeover resume? Get Marvell positioned as a leader in data-moving equipment spanning data centers, 5G networks, and automobiles. With the consumer chip market currently in decline but enterprise markets looking at years' worth of gains, the purchases are already starting to pay off. Revenue has soared, and profitability is fast on the rise as Marvell digests all the expenses related to its acquisition streak.
Data by YCharts.
Even in the midst of the current downturn, Marvell is anticipating it will continue to grow at a mid-single-digit-percentage pace. And once the downturn is over, management believes it will handily outpace average growth of the chip market thanks to its exposure to top secular trends like the cloud, 5G, and automotive technology. Shares currently trade for 32 times trailing-12-month free cash flow, and just 19 times one-year-forward expected earnings per share. I'm a buyer at these levels.
