The semiconductor manufacturing sector is gearing up for a potent surge in the coming years. From artificial intelligence systems to self-driving cars, the need for powerful microchips is soaring everywhere. According to Semi, the global industry association representing the electronics manufacturing and design supply chain, this robust growth signals a promising future for companies that specialize in chipmaking equipment.
Semi's projections suggest a 60% revenue surge in the sector over the next three years, underscoring the compelling investment opportunity in this cornerstone of the digital economy. With such a promising outlook, a panel of tech experts has pinpointed three unique investment opportunities set to thrive amid this market expansion. Let's delve into these exciting plays in the semiconductor capital equipment, or semicap, sector.
A hot name in chips that few are paying attention to
Nicholas Rossolillo (KLA): I'm a big fan of semiconductor manufacturing equipment stocks. Industry leader Applied Materials (AMAT 2.98%) was my first love, and I later added lithography specialist ASML Holding (ASML 2.04%) to my portfolio. But there are actually three other top companies that control the chipmaking equipment space along with these top two. One of them gets little fanfare: KLA (KLAC 4.95%).
KLA's specialty is metrology -- a fancy word for measuring the dimensions of stuff -- and process diagnostic and control, or PDC, an inspection process to make sure manufacturing of chips is proceeding properly. KLA is the leader in metrology and PDC by a long shot. Admittedly, though, measurements and inspection sound like an incredibly boring and unsexy business to invest in.
However, nothing could be further from the truth. KLA's advanced machines are so nerdy that they seemingly approach the realm of science fiction, able to identify and qualify patterns and materials at the atomic level. As chipmaking gets more complex, KLA's importance only grows. Without KLA equipment, it would be next to impossible to profitably manufacture advanced, tech from smartphones to electric vehicles. Much research and development in making the cutting-edge tech of tomorrow is also carried out using KLA's nanoscopically precise machines.
This makes KLA stock a superb way to invest in the advancement of all things computing technology for the long term, as demand for the company's metrology and PDC services steadily increases with time. In fact, even in a down year for the chip industry overall, KLA's revenue is expected to fall less than average before resuming strong growth next year.
And the best part is that KLA has a strong track record of doling out cash to shareholders. It's averaged a 15% per-year dividend growth rate since 2006 and frequently repurchases stock along the way.
Image source: KLA.
At this juncture, most of the investing world has never heard of KLA, let alone paying attention to the long-term opportunity it presents. The stock trades for a reasonable 19 times trailing-12-month earnings. This semiconductor company deserves some of your due diligence time.
It's time to unmask this growing semicap expert
Anders Bylund (Photronics): You can't make modern semiconductors without a top-quality photo mask, which pairs with shortwave lasers to etch theoretical designs into silicon wafers. Photronics (PLAB 1.87%) isn't the only name in the photo mask game, but it's the only way for American investors to make a pure-play bet in this particular niche of the semicap market.
And I think that's a very good idea right about now.
Photronics has captured a healthy 19% share of the global photo mask market so far. Five years ago, the market share stopped at 13%. In other words, Photronics is quietly stealing market share from a group of global giants in an expanding market sector.
Some of this sector-beating growth comes from the company's leading position in photo masks for organic light-emitting diode (OLED) screens. This explosive growth market is finding traction in the field of large-screen television sets these days, to be followed by expansion in automotive and industrial applications as well as ultra-efficient, flexible, and transparent lighting panels.
So Photronics burns the candle at both ends, and investors have taken notice. The stock has gained nearly 50% year to date thanks to a stellar third-quarter report in May. Even so, with share prices hovering near 20-year highs, the stock looks downright cheap. Photronics shares are changing hands at the affordable valuation of 12 times earnings or 1.2 times sales, making it a solid value investment in any economy. With both the OLED opportunity and the core semiconductor equipment market potentially heading into an exciting period of growing demand, this looks like a great time to pick up some Photronics stock on the cheap.
Could this small-cap metrology player grow into an industry giant?
Billy Duberstein (Onto Innovation): Of the semiconductor equipment manufacturers, which is an attractive segment in its own right, none may have more upside than Onto Innovation (ONTO 4.08%), because most of the larger semicaps already have high market share and market caps in the tens or hundreds of billions. However, Onto is a smaller player looking to get bigger, with a market cap of just $5.1 billion. As of now, Onto has the third largest market share in metrology.
And bigger it could get, by virtue of Onto's exposure to some of the most attractive long-term chip trends: leading-edge node production, high-bandwidth memory, advanced packaging for "chiplets," and specialty power chips. The first three trends all play into the artificial-intelligence boom, while specialty power chips play into the ongoing adoption of electric vehicles.
Not only that, but Onto has also gained share and won accolades with its acoustic inspection technology and AI-based software, which is especially useful for spotting defects for the most exacting leading-edge nodes. Since 2019 -- the time when Onto was formed out of the merger between Rudolph Technologies and Nanometrics -- Onto has grown revenue at a 25% annualized rate, while overall global wafer equipment spending has grown at a 20% rate in that time.
While Onto hasn't been able to escape the chip downturn, it's also using this downcycle to improve its supply chain and lower its structural costs. Management believes these cost reduction initiatives will result in $25 million to $30 million in annualized costs. That should go a long way, considering Onto's 2022 net income was $223.3 million.
Today, Onto trades at 28.3 times this year's estimates, which should mark the trough of the cycle, and 22.8 times next year's estimates. However, Onto also has high excess cash of over $583 million, or more than 11% of its market cap. So, ex-cash, Onto is a bit cheaper than that. Management is also using that cash to make tuck-in acquisitions and repurchase stock, which should be accretive to the long-run earnings per share over time.
Given its above-normal growth potential within an industry set to grow a strong long-term rate thanks to the AI and EV industry booms, Onto is a promising pick, even with the stock near its all-time highs.
