Semiconductor manufacturing is receiving massive attention. The world needs more powerful and more power-efficient computing, and the transition to electrification (cars, the energy grid, etc.) is underway. As a result, all indications point toward chips going from about $600 billion in global annual costs today to $1 trillion or more by 2030.
Lots of equipment will be needed to support this big increase in manufacturing. Photronics (PLAB 1.87%) is a small company harboring a very specific niche, photomasks, but one that could be a hidden gem in the coming chipmaking boom.
Photronics' key cog in the chip supply chain
Lithography is a key step in the manufacturing of chips and flat-panel displays (FPDs, LED and ultra-high-definition OLED displays). Before it becomes part of a computing system, a chip is part of a silicon wafer. These wafers undergo many manufacturing processes that create the ability for the eventual chips cut from them to conduct or insulate electricity, the foundation of computing technology.
Lithography is the step in which the wafer is coated with photoresist material that reacts with light. The photomask is a type of reticle, a plate (usually made of quartz) that has microscopic images of electrical circuits cut into it. The light passes through this reticle, with the patterned light reacting with the photoresist material on the wafer and crafting the tiny features that will enable the chip to do computing work (or for an FPD to display images on a device).
Given how increasingly expensive chipmaking has gotten over the decades, the semiconductor equipment manufacturing space largely consolidated around a handful of leaders. But small Photronics held out as an independent entity, focusing just on photomasks. It's one of the largest companies in this niche, competing against mega-conglomerates like Applied Materials and South Korea's SK Electronics.
Despite its underdog status, Photronics has done well, especially since the Great Recession of 2007-2008. Like a lot of tech companies, it enjoyed a surge in sales during the pandemic's height, when the world went all-digital for a while.
Data by YCharts.
A new phase of slower growth, but is that bad?
More advanced (and thus more expensive) photomasks are driving this modest growth, which is expected to continue into 2024. Governments around the world are ramping up investment in domestic semiconductor production, which is benefiting Photronics too. LED and OLED screens are also undergoing a period of investment as they gear up for what could be a strong rebound year in 2024. Photronics derives about one-quarter of its sales from this FPD space.
The real beauty of Photronics isn't its incremental revenue growth, though. Rather, it's the company's ability to crank out even better profits as its customers adopt more complex photomask products. Management reports it is on track to achieving its target of 30% or better operating profit margins for next year.
Data by YCharts.
Photronics also has a squeaky-clean balance sheet, with $476 million in cash and short-term investments and debt of just $20 million at the end of July.
Who might be interested in this stock
I'll emphasize here that Photronics is not likely to be anywhere close to being the fastest-growing player in the semiconductor manufacturing equipment market. Its focus on just one product type will also make it more susceptible to adverse downturns in the market, versus the big "fab five" (Applied Materials, ASML Holding, Lam Research, Tokyo Electron, and KLA Corp).
Nevertheless, for investors who are looking for a deal and don't mind more gradual growth over time, Photronics could be a value right now. The stock trades for just 11 times trailing 12-month earnings per share, or just 9 times trailing 12-month free cash flow. Given the wild cyclicality that can be inherent in the chip manufacturing space, some babysitting might be warranted for this company. Nevertheless, for those interested in investing in the coming semiconductor boom, Photronics might be worth keeping tabs on.
