Semiconductors - the new oil

Semiconductors (semis) are to the technological revolution what oil was to the industrial revolution.  Today there is a severe global shortage of semi’s, and it matters.

The shortage has resulted from a combination of natural disasters impacting manufacturing regions on top of what was an already fragile supply situation.  Severe frosts in Texas saw Intel shut production for a few weeks, and Taiwan, which is responsible for over 50% of all semi manufacturing, is suffering from severe drought. Semi manufacturing is a very water intensive process according to Delian Entchev (Senior Analyst, Aoris Investment Management).  He says that up to 20 million litres of water a day is required for one factory.

The shortage matters not only to those investors with exposure to semi companies, but investors also need to think about the domino effect on other industries that rely on semis.

The obvious products relying on semiconductors are PC’s, tablets and smartphones but many investors would be surprised to learn that semis are in other household items such as a fridge, lawn sprinkler, tv and microwave. 

The auto industry is another large market for semis and has been one of the high profile casualties of the chip shortage.  Several car factories around the world were forced to temporarily shut down production due to insufficient supply of semis.  Ford Motor Co anticipates a $2.5bn chip shortage cost. 

Recently the CEO’s of Cisco and Intel, respectively major buyers and producers of semi’s, predicted that the shortage could last another couple of years because demand continues to increase and production can’t be ramped up overnight.

Runways for Growth

Entchev says that the average petrol engine car contains around $100 of semis while a full battery electric car contains up to $1,000 of them.  Clearly the shift to electric cars will provide a growth runway for semis.

Douglas Isles (Investment Specialist, Platinum Asset Management) says that other growth tailwinds for semis include the move to 5G, the Internet of Things, autonomous driving, artificial intelligence and machine learning. 

The semi design industry generated revenues of US $466bn in 2020 and leading IT research firm, Gartner estimates that the industry can grow on average by 5-6%pa over the next 5 years.  

Entchev says that there are many different ways that investors can participate in the semi industry growth including:

-       Suppliers of materials such as silicon wafers on which semis are built

-       Producers of semi manufacturing equipment

-       Companies that provide outsourced manufacturing of semis

-       Software used to design semis

-       Chip designers such as Intel and Samsung

Isles says that Platinum Asset Management has had a large exposure to the semi sector since 2018, but their investment in Samsung goes back over 20 years.  Samsung has evolved to become a dominant player and today adjusting for cash on its balance sheet trades on about 12 times forward one year earnings (source: Factset)

Entchev says that Aoris’ preference is to invest in businesses that indirectly benefit from the advancement in semis, as it is very difficult to predict which semi companies will win in the future. A good example is Accenture, the largest global IT consulting business, which helps its customers deal with the technological changes that semis enable, like cloud computing.

Investors could also gain exposure to the semi industry through global managed funds and global ETF’s.

Risks

The semi industry is fast moving where customer needs can change quickly resulting in today’s products becoming redundant.  

It is generally considered that this is a cyclical industry, with two of the largest end markets being to automotive and industrial customers, however Isles said following industry consolidation the economics of semis has improved.

And then there are the geo-political uncertainties surrounding Taiwan which dominates semi manufacturing.  One of the most important developments in the semi industry has been outsourced manufacturing.  In the 1970-2000’s semis were all made internally by the companies that designed them.  Taiwan Semiconductor Manufacturing Company (TSMC) with support from the Taiwanese government created the first company dedicated to manufacturing designs from other companies.  Today TSMC has 52% share of all semi manufacturing and over 80% share of the most advanced chips.

The electronic components of devices that we take for granted today are an important long term investment thematic.

 

 

The article was written by Mark Draper (GEM Capital) and appeared in the Australian Financial Review during May 2021.