I 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
Overview:
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.
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.