Category: Featured

In-depth analysis or commentary on companies, securities, or the economy

What Keeps Me Up At Night? The Bullwhip Effect Plays Out

Reading Time: 5 minutes

When I look around at the risks facing the market expectation, there is one main concern I have. The Bullwhip Effect.


We saw a massive “destocking” of inventories occur in 2020 (the initial response to the pandemic). Then, a massive “restocking” occurred as demand returned with limited inventories. But on the other side of that is typically another “destocking” cycle as supply chains tend to under and over shoot.

What we saw in 2020-2021 appears to be a bullwhip effect on steroids.

In other words, today’s shortages become tomorrow’s gluts. What appears to be endless demand may be simply pulling forward purchases to replenish inventories, leading to oversupply.

I was listening to Joe Weisenthal on the Notes from the Crises podcast and he put it well. He said something like:

A pork producer does everything to prepare the pork, but then he doesn’t have styrofoam trays to put it on. He can’t deliver the meat despite solid demand and the customer’s shelves go empty. The customer thinks supply can’t be met due to unexpectedly strong demand, so they double order to make sure they have it. The pork supplier says he won’t be caught short again too… so he triple orders styrofoam. On and on…

As you go further and further upstream (that is, further away from the customer), these swings are more pronounced (that’s why it’s called the bullwhip effect – the handle of the whip barely moves, but the end of the whip – the upstream producer – swings massively up and down). Demand information has to travel up the chain, like the telephone game, before it arrives at the upstream supplier.

Is it any wonder we’ve seen a lot of these shocks and surges in pricing commodities?

To further explain, we had a massive, but short lived, demand shock in 2020. Companies halted purchases and decided to sell down inventory to better match demand in what they thought could be a depression or GFC 2.0.

Here’s an example from Atkore, a company that sells conduits around electrical cords for buildings, talking about this in May 2020. They are essentially saying they think demand is going down a lot so they are destocking in the channel.

What happened with Atkore? Well, demand held in very well. Pricing surged as they have commodity pass-throughs, so Atkore is going to do $900MM of EBITDA in ’21. Normally they’d do ~$300MM. They even are telling the street that it isn’t sustainable, yet street estimates still have them at $600MM of EBITDA in ’23 (likely a wet finger in the air)…

Here is another great one from Louisiana Pacific, which sells OSB (a type of plywood into buildings) as well as siding in May 2020:

Neither these companies, nor their customers, knew that demand would actually come roaring back. Inventories, in turn, would be *too* depleted, caught short, and prices surge.

Winter Storms and Hurricanes of 2021 Exacerbated Normalization

Let me add another piece into the mix. Chemicals. You know, the upstream products that go into everything?

PPG had a great comment on how much the Winter Storm Uri impacted 2021 in getting supply chains back to normal:

Yes, 95 plants (!!!) in Q1 2021. That surely can cause a disruption, tighten inventories, causing key input prices to surge… which they did for key plastics.

What are two key end markets for plastics and chemicals? Autos and housing.

Lyondell, another major chemical producer, but very upstream, noted in one of their earnings calls that they weren’t actually sure what demand is!

“We really don’t know where the real level of demand is because we’re so supply constrained.”

Now, Lyondell spun that as a positive, but that’s concerning to me.

In hindsight, it is obvious to see how that rippled through supply chains. But many smart investors are saying, “too much stimulus, so that has resulted in inflation.” That is way too simple. As prices rose, that had to be passed down the chain in a market desperate for supply. What does this mean for when supply relaxes?

Shipping Adds in Another Layer of Complexity

Another thing you can point to rippling through the chain is simply global shipping is normally deflationary (the more containers per ship, from low cost areas, the lower the cost per each individual unit). But bottlenecks prevented that.

In addition, in a globalized economy, high shipping costs can keep low-cost producers OUT of the market, driving up prices. If this happened in many industries, but you think shipping normalizes, why do you think those prices won’t normalize?

I bring up shipping because the constraints there caused further scrambling for orders, which again makes me think the bullwhip effect is on steroids – it is on a global scale.

Each of these things will be resolved. In some cases, I think we are already starting to see them being resolved. Shipping rates are coming down from peak, polypropylene and polyethylene prices are coming down as “supply has now outstripped demand”, steel is coming down from meteoric peak. Lumber ripped, fell, and though admittedly is coming back (though there are persistent supply / demand issues there).

No auto dealer likes having nothing to sell. No retailer wants to be the one without seasonal items for the holidays.

In fact, in an Odd Lots podcast, Joe Weisenthal and Tracy Alloway discussed how a small-fry customer can be booted from the container ship in favor of a large customer (a la Walmart). Companies are doubling ordering there too so they don’t get kicked from the boat. All this double ordering leads to very strong backlogs, but is it “real” demand?

Inflation in my mind right now is very much being caused by a supply chain issue and that will be resolved. It is inter-relatedly tied to these inventory & shipping issues.

I am actually very bullish for the next few years. I think we are operating in a very exciting time for investments. At the same time, I am highly cautious underwriting things right now that say they have amazing backlogs. The market is forward looking. As some companies burn through insane 1x earnings, I don’t think they will perform well.

I also think despite some podcasts and WSJ articles, investors are impatient and may ignore the bullwhip reality until they see it with their own eyes. If they don’t see the market “normalize” in 6 months, they tend to think we are in a “new paradigm.” I’m cautious saying much actually structurally changed post-COVID.

I’ve written up some things that still look cheap, like select retailers, but I would much prefer something like auto suppliers in the cyclical space where I think I have a high degree of likelihood of where production is going.

Oh, and by the way, this isn’t the first time we’ve seen something like this. Arguably post-GFC with China stimulus was similar (go back and look at what happened to commodities then), but that didn’t last. That said, this is on steroids…

Bullish on Auto Suppliers $MGNA $AXL $LEA $ADNT $GTX $NGVT $STRT

Reading Time: 5 minutes

In my ’22 outlook piece, I said I am bullish on auto supplier stocks:

When do you have recession levels of production, but demand has already improved drastically? Even if demand slows, production has to be elevated to restock the channel.

Investors are always worried about demand and production levels in autos given high fixed costs, but the visibility of go-forward production levels is obvious: UP!

I want to lay that thesis out a bit more and highlight a basket idea I have. I already have American Axle and Strattec in my recs, but I am adding Magna International, Lear and Ingevity to the mix. I discuss others below as well. 

Let me also state I know auto supplier stocks are value traps – they trade at low multiples for a REASON. Many reasons. But let’s lay out the bull case. 

Why am I so confidant in auto restocking?

First, here is annual SAAR, or the number of units sold each year. We typically ran 15-17.5MM units in the US:

Domestic production is running at just 12.5mm units. Here’s inventories, in units

And here is inventory to sales ratio. Normally I don’t prefer this, because a 1x elevated pace can make it look bullish at the top of the cycle. But that isn’t what happened here. 

It is no wonder why used car prices have surged – we are short cars. As I put in my prior posts, many dealers I follow have less that 25 days of inventory on hand compared to 60+ days pre-COVID. 

With no production issues in 2022, I think it likely takes until 2023 for passenger and truck inventories to normalize.

Here are some comments on that:

So I think what you’ll find is that, as you look through 2022, the first half, we’ll have less supply than through the second half. And as I said earlier, we see this mitigating over time. It may extend into 2023. But I would say that we should be back up and running based on what we’re seeing today, a run rate, the end of next year into ’23. And then in 2023, we’d start to rebuild our inventories.

-John Lawler, CFO of Ford

As we indicated, we see a very bright future and a very strong demand for the various platforms that we support for years to come, especially because of where the inventory levels are and because of the consumer demand that exists in the marketplaceAnd as I said, as fast as the OEMs can build them, the consumers are buying them. 

So I think it’s going to take an extended period of time to rebuild the inventory levelsThat’s going to put us in a very healthy position to generate a lot of cash for our business. We’ll use that cash as we always have to continue to support our organic growth, a big shift in our organic growth is towards electrification.

We think it will take a minimum of 24 months to replenish the value chainAnd therefore, we see some bright days ahead of us as it relates to our ability to generate cash, pay down debt and fund our electrification growth in the future.

David Dauch., CEO of American Axle

I think if you look at ’21 versus ’22… the biggest impact on decrementals/incrementals is really the start-stop and the inefficiencies that we have in our facilities. And I expect that’s going to go away as we work through ’22And that’s the biggest item order of magnitude against some of the inflationary pressures are — will have — I expect will have an impact.

-Vince Galifi, Magna International CFO

What are the best plays?

I may not know the best plays, but this is what I am doing. I’ve already written up $AXL and $STRT and those are my top ideas for this.

Here are some other thoughts. Note, a lot of my estimates tend to be higher than consensus, because sell side tends to stink at modeling fixed-cost absorption. I should also say I am looking for cheap names I don’t think will underperform for some other reason (e.g. EV risk) and that’s why I exclude a Garret Motion or a BorgWarner – I just want exposure to my thesis. I do like those too and full disclosure am long the GTX prefs in my PA.  

  • Magna International ($MGNA) should benefit from increased production plus. Valuation is undemanding at ~5.5x 2023 EBITDA.  This is generally a “safe” auto supplier name as they have less exposure to “EV risk”, in that some suppliers products may be disrupted. MGNA is “drivetrain agnostic” as they say, but also pretty diversified across exterior parts, drivetrains, seats, etc. There was this report stating Magna was involved in the powertrain for an Apple car. Who knows, but MGNA really does have its hand in a lot of EV related things, but also is generally tied to auto production. 
  • Lear ($LEA):  Lear is dominant in seats (Lear and Adient each control about 22% of the market, followed by Magna at 7%, and then other small players). Lear doesn’t really have EV risk in my view with seats. They are also a leader in wiring components. With EVs and ICEs having higher electrical content per vehicle, Lear is a long-term winner.  I do think the street may be underestimating Lear’s profitability when it is running flat out, though if I am wrong, Lear’s upside is admittedly capped. But assume 10% EBITDA margins on ’22 consensus sales, it trades for ~5.75x EBITDA. Lear last earned these margins back in 2013-2014 when they were running really strong. Lear used to buyback a lot of stock – back in 2013, they bought back $1bn, or 16% of shares. I love it when companies buy back huge slugs of stock at one time
  • Adient ($ADNT): A possible play, but turnaround story (former spin from Johnson Controls, margins well below Lear).  I think I am a pass here, but bring it up for those who want the highest beta. The hardest part is they generate basically no FCF. If you buy the turnaround story (mgmt says 500bps of margin improvement was disguised by inflation in ’21) it could make a lot of sense. An improving ROIC + Growth = winner stock. And their growth is near 1:1 with production.

I know, I know – there are a ton of suppliers and so I don’t have to cover them all. Here are some other tertiary ideas, though: 

  • et al ($CARS): With tight inventories, dealers and OEMs have been able to cut incentives as well as advertising. When inventories normalize, so should incentives and ads. Up to you on this one. does look optically cheap, but I don’t know it well enough. 
  • Ingevity ($NGVT): Under-discussed name and likely requires its own post as it is a fascinating business. This is a chemical business attached to an auto-component business. A former spin-out of Westrock, the chemical business uses pine-based chemicals to make certain resins used in paving, inks, O&G, etc.  The auto component is basically a vapor control system in cars that utilizes activated carbon. While I said “no EV risk,” this truly is a great business as they essentially have a monopoly on the business (and it has 56% EBITDA margins in good times! Alas – because of lower auto production, Q3 margins were down >800bps. Guess what happens when that reverses?). >10% fwd FCF yield is too cheap. 

’21 Recap & ’22 Outlook: Bullish on Auto Suppliers & Select Retail, but Where is the Consumer?

Reading Time: 4 minutesI had a pretty good 2021. $SPY was up about 28% this year and I am up about 33% in my PA. My PA is a bit different than what I write up on here though. My main benchmark I use too is the Russell 3000 to capture an apples-to-apples comp of what I write about. I don’t compare annual results on the blog, but instead look at performance of my picks compared to just putting that money in the R3K (all on an equal-weight basis) until I say it is time to close out.

As you can see below, I am still outperforming by about 20 percentage points based on all of my picks. Unfortunately, the picks from this year haven’t performed. I am a long-term investor though, so I wouldn’t expect these names to play out in 12 months anyway.

Find further notes below the chart.

Here are some quick thoughts as I recap ’21 and look out to ’22:

  • Thank you for reading. The blog had 40% more views this year than last and about 4x the views of 2 years ago. I hope to continue to drive engagement!
  • Laughable to compare what I first wrote about to today.
    • I have a saying that “when you hear a friends value-stock pitch, give it 6 months to “season”. Your friend thinks “it can’t get any cheaper!” and it invariably does.”
    • I think that’s what I was doing when I first started the blog. I had such a feeling Nexeo was cheap, I had to write about it. It eventually got acquired by a strategic, but wasn’t that compelling at the EoD.
  • Some of my worst performing ideas of ’21 I am still incredibly bullish about.  
    • I just did an update on $ABM, $LGIH is a long-term compounder that requires patience, and I have become even more bullish about my auto supplier thesis. I get more into auto suppliers below.
    • Several names I picked from last year are not doing well comparatively, but I continue to like including $BIG and $NCMI – everything at the theater chains has proven they are not dead. Ad dollars will follow.
    • A lot of my performance has been driven by good picks in 2020. Let your winners run, as they say. I still see value.
  • Theme of 2021: a lot of auto and retail… is it a red flag as that is what I am bullish about in 2022??

        • But here’s where macro meets micro: I don’t understand why consumer sentiment is SO BAD.  I hear the inflation argument – that sours consumer moods. But it seems hard for cyclicals to work too long without the consumer.
        • Why is consumer sentiment at 1990s recession levels? Or below 2001??

      • Like I said, I am staying long and strong retail and auto next year, I see fundamental momentum and I personally think a lot of names have changed their business models for the better, but I see the negative tea leaves forming as well.
  • My 2022 call is auto suppliers are going to crush it
    • I plan on doing another post on this, following my first on American Axle and the other on Strattec. Auto suppliers definitely are a segment full of “value traps.
    • In my next post, I’ll talk about low inventories in the channel and how much (and how long) it will take to restock.
    • Here is the bottom line: when do you have recession levels of production, but demand has already improved drastically. Even if demand slows, production has to be elevated to restock the channel.
    • Investors are always worried about demand and production levels in autos given fixed costs, but the visibility of go-forward production levels is obvious: UP! 

Another positive thing I saw was from twitter. Sorry a couple other macro things:

Lastly, Consumer balance sheets do appear in good health and well below trend low. More capacity to lever up!

That’s all for now! Stay tuned for that next post.

Candle in the Tailwinds: Bath & Body is “Secret SaaS” in Plain Sight $BBWI

Reading Time: 7 minutesL Brands officially spun off Victoria Secret and now Bath & Body Works (BBWI) is an independent company. This is great news to me as I think BBWI is a “Secret SaaS” business, a topic which I discussed before and will get into here.

Why do I like BBWI?

  • High margin category with growth tailwinds (beauty, fragrance)
  • Fragrance has difficulty translating to online without trust – Brands matter
  • BBWI has high customer loyalty – leaning into that loyalty even more; “Secret” razor, razor-blade model in fragrance
  • Like many other brick-and-mortar retail (B&M) businesses, discovered the power of omni-channel during COVID – I believe it will structurally benefit the business
    • Many focus on LTV / CAC as well as gross profit return on sales and marketing for SaaS and DTC businesses – the thinking being because it is a more variable cost business and you can tie the two
    • But strong B&M brands have high initial upfront investment (e.g. the stores), and then serves the customer and drives loyalty with more limited incremental spend. We shouldn’t forget this.
  • Business has been “trapped” inside L Brands
    • Not sure analysts gave BBWI its full consideration when it attached to VS – a brand that is facing significant competitive pressure and heavily dependent on malls.
  • Not as impacted by supply chain issues, but the “baby could get thrown out with the bathwater”
    • BBWI sources most products from their facility in Ohio, not China. 80% sourced from US. Broader sell-off in retail could create an opportunity

As an aside, the Victoria Secret spin may end up being like Joel Greenblatt spin-off: the market hates VS so much that it gets to an extremely attractive price as people sell the spin. Time will tell. Don’t get me wrong, I would probably be one of those dumping VS if I received it.

Business has been “trapped” inside L Brands

I’m going to start with the last point first because it is quick. If you listen to the latest BBWI call, it is clear to hear analysts are still a bit confused how to model BBWI – it hasn’t been standalone before. Things like normalized capex, SG&A, and others were frequently brought up. I had to do some digging to find long-term gross margins for BBWI. All this is to say – you have to do some work to learn the most you can about BBWI standalone.

Second, BBWI and VS fortunes have been the complete opposite. As such, if you just looked at L Brands as a whole, you might miss the success story within occurring at BBWI shown below:

High margin category with growth tailwinds (beauty, fragrance); Fragrance has difficulty translating to online without trust – Brands matter

BBWI has 28% operating income margins, which both shocked and didn’t shock me.

Granted, this is LTM, where they benefitted from more of a “DTC” model during COVID and less promotions, though their physical stores were closed for 90 days in 2020.

On one hand, the margins are top quartile. On the other, fragrance and beauty are notoriously high margin categories.

Why is fragrance a high margin category? The packaging and everything involved with fragrance related products are usually a small cost. What drives the sale is the actual smell – and that takes technical know-how that is hard to replicate.

It’s analogous to beauty – beauty products are high margin because it tends to be a tough category to replicate, it is tough to get good distribution, and there is a degree of customer trust and loyalty (“hey this worked for me, you should try it”) which is hard to break into. Oh – and obviously consumers will pay up for these products if they “work”.

BBWI is at the center of some of these trends. Clearly, you can see their growth in the numbers I posted previously as well.

BBWI has high customer loyalty – leaning into that loyalty even more; “Secret” razor, razor-blade model in fragrance

I like the simple “razor, razor-blade” model from BBWI. They have “wallflowers” which consumers plug into the wall and dispenses the fragrance. These plugins can be simple or decorative, like seasonal ones shown below.

They  aren’t too cheap, as a razor is for the blade, but the scents offered are consistently refreshed and tend to be “optically” cheap. For example, 5 refills for $24 tends to be a consistent sale.

Compare that to one Yankee candle which is more than that for just one candle (which will burn longer, but the optics to a customer aren’t the same. I could dwell on this point, but to me, I don’t think consumers do that math).

I hate anec-data, but my wife and mother are consistent buyers here (thank you Peter Lynch for recognizing this investment thesis!).

Management has several slides that show they are thinking about this the right way. Find ways to increase retention rates and drive value.

If this is Secret SaaS, can we look at BBWI metrics with the lens of SaaS?

This isn’t perfectly accurate, but I think it is instructive. If you assume 15% of SG&A is for attracting incremental customers, then the company has a ~3 year payback. Again, that is just a fixed assumption and hard to get a direct feedback response for a legacy B&M player.

However, this is extremely difficult to determine for B&M retail. Especially one where we have limited stand-alone detail… But as noted before, the investment in SG&A comes upfront and to some degree, it is a “build it so they come” model.

But Warby Parker put it well in their S-1:

“While we have the ability to track where our customers transact, we’re channel agnostic to where the transaction takes place and find that many of our customers engage with us across both digital and physical channels; for example, many customers who check out online visit a store throughout their customer journey, while others choose to browse online before visiting one of our stores.”

To me, it is clearly the other way around for fragrance. Once you get comfortable that BBWI isn’t going to sell you something awful in their fragrance line up, you are likely to buy online from them (and perhaps, not from a brand you don’t trust). Or, you find several fragrances you really like and consistently re-order them.

I think they are just too interlinked to derive anything useful from this analysis. Instead, we can just focus on margins and FCF to get a sense of health.


On that B&M note, the company is 35% mall (says 99% are cash flow positive), 31% are off-mall (i.e. stand-alone stores, all cash flow positive) and 31% digital – super-enabled by COVID. They also have a small, international franchise business making up the balance.

I see a similar set-up longer term as Big Lots, which I wrote about how they can pivot their footprint. You can see in the table below that off-mall stores and Class A and B malls are clearly worth keeping. Class C and D? Less… And the Class D malls have the shortest lease terms remaining.

BBWI specifically called out closing stores in non-viable declining malls and remodeling others for an sales uplift.

BBWI Driving More Loyalty

While I’ve already stated why I think BBWI has a loyal customer base, BBWI is doing more. It makes sense – to create value from their existing customers, they need either more trips or for them to spend more in stores per trip.

Loyalty programs typically achieve this. For example, offering a 25% off coupon to loyal members typically gets them to either start an order they might not have done previously, or add one more thing… this incremental sale drives a lot of value for the retailer.

BBWI is testing that now: customers in the loyalty program spend 30% more than non-loyalty members.

A Quick Word on Value

BBWI is expected to generate $5.2BN in FCF between 2022-2025, or 30% of market cap. I even think that could be conservative. The company is returning significant amounts of cash to shareholders (continued the L Brands dividend, doing a $1.5BN share buyback) and I think the valuation is very reasonable at around 10x EBITDA.

However, they are earning high margins lapping a COVID bump. Essentially, the company saw a significant increase in sales, especially online, despite their stores being closed for 90 days during the pandemic. In the 2H of 2020, they were able to pull back on promotions which boosted margins.

I am not too concerned. This is a wide gap, but management targets $10BN in revenue (from $6.4BN in 2020) over the next 3-5 years. They assume some of this margin will be given back and EBIT margins will be in the low to mid-twenties. The stock is currently trading at 10x EV/EBIT on this forward number. Not too cheap, but not overly expensive given the business model either.

If I take the $6.4BN of revenue they did in 2020, apply a 22.5% margin to it I get $1.4BN of EBIT instead of $1.8BN. Based on their PF balance sheet for the spin, I calculate ~$910MM of tangible invested capital. This is true for most successful retailers thanks to leases (which can be a double edged sword), but that ROIC is fantastic.

Bottom line, I think BBWI deserves a premium multiple.


Entegris: Picks & Shovels on Secular Semiconductor Growth $ENTG

Reading Time: 5 minutesI have a picks-and-shovels play on semiconductors. While it may not look “optically” cheap, I think Entegris can compound earnings at a very fast rate thanks to the secular growth in semiconductors as well as changes in semiconductor technology that will require more products from Entegris.

While I say Entegris stock is a “play” on semiconductors, I would underline that this isn’t a short-term trade for me. I am going to lock this name up in my coffee can portfolio and throw away the key. There actually is a second player as well I am reviewing, but haven’t gotten fully comfortable yet.

Why Entegris?

  • Picks-and-shovel plays on semi growth (internet of things “IoT”) which should grow well in excess of GDP
  • Semiconductors are notoriously cyclical; there is a capex-exposed portion of the business (30%), but large chunk benefits from recurring revenue (70% of products are consumed in wafer production)
  • Best-in-class technology which sets them up well in changing landscape
  • Underfollowed name, but center of several long-term trends
  • Dry powder: <1x levered, $400MM of cash on hand to make M&A or investments

While semiconductor manufacturing is complex, I want this write-up to be simple. I think once you just understand the basics, it is easy to see how Entegris can be a winner for the long-run.

So I’m going to put the main drivers of why Entegris is a winner right here:

  • The number of production steps in semiconductors is increasing…increasing demand for Entegris’ materials
  • As the steps increase, yields tend to decline…also increasing the need for materials to improve yield (which Entegris provides)
  • Lastly, Entegris’ materials improve device performance. Performance demands are also increasing in smaller structures


Entegris is a chemical / materials company that helps with the production of semiconductors.

Semiconductor production requires hundreds of highly complex and sensitive manufacturing steps. You’ve probably seen videos of semiconductor fabs where people need to dress in full radioactive-like suits to avoid contamination in the process.

Silicon wafers are the core building block for semiconductors, and during the manufacturing process, a variety of materials are applied to silicon wafer to build integrated circuits on the wafer surface.

I snagged this picture from an ASML page. If you don’t know ASML, they also are a picks-and-shovels play on semiconductor growth, particularly high value-add. But I thought this chart showed the processes well.

EUV beginners

Entegris is one of the companies providing these materials in each step. Here are some examples:

  • Etching
  • Deposition
  • Photolithography
  • Ion Implant
  • Chemical Mechanical Planarization (CMP)

I’m not going to explain each one to keep it simple, so please go read the 10-K for that (which I link to above).

Wafers are consuming more materials as the production process becomes more complex. Nodes in semiconductors are getting smaller, which requires more processes and yields potentially go down with each step. This requires new materials of increasing purity, quality, and stability to maximize yields.

For example, in memory chips, the industry is migrating to 3D NAND which requires 128 layers from 64 layers previously. In logic devices, there is a shift to 7 nanometer (nm) from 28nm. In both of these cases, there has been a 2x increase in material spending.

Fabs must reduce defects at each individual step in order to achieve the same final yield. I got this chart from this website which breaks down why the steps are increasing, but this reduction of the situation helps me understand it clearly.

Entegris noted, “by 2022, approximately 25% of the wafer produced in logic fabs will be at 20-nanometer technology or below. And in that same time frame, we expect almost all 90% of the 3D NAND chips to have 96 layers or more” – so that is very positive for Entegris.

Additionally, these materials play a role in performance of the chip. As the Entegris explains:

New materials have played a significant role in enabling improved device performance, and we expect this trend to continue. As dimensions get smaller, new materials will be required to enable transistor connectivity. For example, leading-edge semiconductor manufacturers are moving towards atomic layer scale, where the precision of the manufacturing process and purity of the materials used is vital to maintain device integrity. These materials need to be supplied and delivered at ever-increasing levels of purity and control, from point-of-production to point-of-dispense on the wafer.

So again, the boiled down, simple thesis:

  • The number of production steps is increasing, increasing demand for Entegris’ materials.
  • However, as the steps increase, yields tend to decline – also increasing the need for materials to improve yield.
  • Lastly, these materials also help improve device performance. Performance demands are also increasing in smaller and smaller structures

All of this paints the picture of Entegris compounding at a multiple of whatever semiconductor growth is.

Historically – you can see that is the case:

Quick Word on Value

Entegris valuation isn’t for the faint of heart (neither is ASML mentioned earlier), but the I think the dynamics outlined here, as well as M&A opportunities, makes me think the company can grow FCF/Share at double digits for a long-period of time.

The stock trades at 37x 2022 FCF, or <3% yield. So to get a 15% IRR, I somewhat need to expect a double-digit growth rate.

But here’s the thing that gives me comfort: a lot of capital is being put in to build new semiconductors.

  • TSMC: Investing $100 billion over next 3 years to boost production capacity and R&D on advanced nodes and specialty technology equipment
  • Intel: Announced two new factories in Arizona at $20 billion
  • Samsung: Not disclosed, but analysts expect $37 billion in capex annually in 2021-2023, up from $32 billion in 2020

The current shortage in 2021 is going to leave a lasting impression on the industry and capital is cheap to add strategic capacity. Frankly, odds are several years down the road, we might be oversupplied (a classic cycle).

But the shortage today is here, giving companies comfort in putting new capital in the ground. And countries are looking at their production as increasingly strategic (US vs. China) which may lead to duplicative, but localized capacity. Bottom line: I think that might add even more capacity in the long run.

Again, Entegris is mostly tied to units sold. Semi fabs need to run at high utilization rates (because they are high fixed cost businesses) so maybe that pressure prices down the road, but I can comfortably bet more units will shipped than today.

I recently saw JPM estimate wafer shipments at growing double-digits in 2022, but then moderating to GDP-like growth in 2023+. That seems too conservative to me, but again, Entegris can likely outgrow this due to the factors mentioned previously.