In my Trick or Trend post on my subscription JubakAM.com site on Saturday, March 27, I argued that the increasingly serious chip shortage experienced by car makers was bad for car stocks (since car companies are having to cut production), but good for chip makers who concentrate in the auto sector (since they are seeing rising demand and increasing pricing power) and even better for chip equipment makers (since they were already on a roll to meet higher demand for equipment to expand chip production and are now very likely to see that extra demand for chip equipment run higher and longer.)
I already own shares of two chip makers that are seeing rising demand and increasing pricing power: NXP Semiconductors (NXPI) and Infineon Technologies (IFNNY). I own NXP in my Volatility Portfolio–up 97.16% since June 2, 2020. I own Infineon in my Jubak Picks Portfolio–up 81.38% since May 6, 2019. And I also own shares of chip equipment maker Applied Materials in my Jubak Picks and 50 Stocks portfolios. Applied Materials has been a member of my Jubak Picks Portfolio since January 14, 2021 (for a gain of 21.59% as of the close on March 26) and of my long-term 50 Stocks Portfolio since December 31, 2017 (for a gain of 151.64%.)
Today, Monday March 29, I’m adding shares of ASML (ASML), the leading producer of lithography equipment to draw circuits onto chips. That stock gained 7.14% on Friday and is now up 28.28% for 2021 to date. The shares trade at 52.63 times projected earnings for the next 12 months.
Photolithography is the process in which a light source is used to expose circuit patterns from a photomask onto a semiconductor wafer. According to the company, lithography represented about 27% of all silicon wafer capital spending in 2019.
The company has leveraged extensive R&D spending to capture the lion’s share of the latest generation of EUV (extreme ultraviolet) lithography tools. EUV uses lower-wavelength light to enable chip makers to pack more transistors onto each chip and EUV equipment is essential to chip makers drive to 7 nanometer and 5 nanometer chip technology. (In 2012 the company’s three largest customers Intel, Samsung, and Taiwan Semiconductor Manufacturing made an investment in ASML to enable the company to pursue EUV technology. At the time the three customers acquired a 23% minority equity stake in ASML.)
It’s taken a while for that investment in EUV lithography to pay off but sales of this equipment look to be hitting their stride just as demand for new generations of chip making equipment are soaring. Taiwan Semiconductor Manufacturing and Samsung began to use EUV processes in 2019 and Intel looks to be on a schedule that would integrate EUV technology into its 7-nanometer manufacturing process in 2022. The company shipped 26 EUV tools (these machines sell for more than $100 million each) in 2020 and is on track to ship more than 40 systems in 2021.
One result of the company’s huge installed base of lithography equipment is that revenue from services has actually grown faster than revenue from equipment sales. From 2010 to 2019, Morningstar calculates equipment sales revenue grew at a 9.8% compounded annual rate of return while revenue from services grew at an 18.5% compounded annual growth rate.
I will be starting a position in ASML in my Jubak Picks and 50 Stocks portfolios on Monday, March 29. My 12-month target price for ASML in my Jubak Picks Portfolio is $730 a share. The stock closed at $625.67 on March 26.
Full disclosure: I own Call Options on Applied Materials in my personal portfolios.