Summary
- The CHIPS Act aims to make the American semiconductor (chip) industry less dependent on foreign supplies and more competitive.
- While everyone is focusing on semiconductor manufacturers, it is the equipment makers who make it feasible to build chips in the first place who should benefit more.
- In this respect, one ETF which has more exposure to semiconductor equipment makers than peers is SOXX.
- Economic uncertainties persist while the WSTS points to growth in 2022 and there are also strategic imperatives.
- In these conditions, it is better to wait for the ETF to boost its holdings pertaining to equipment makers, or alternatively, invest in individual stocks as per the table provided.
The purpose of the $52 billion Chips and Science Act is to support the American semiconductor industry, as well as make the country less dependent and more competitive. Its promulgation was carried out with great fanfare by the President together with the industry heads with the signing ceremony attended by the CEOs of Intel (NASDAQ: INTC ) and Micron (NASDAQ: MU ), and others.
Many see these companies as the main beneficiaries of chip production on American soil which is likely to shorten the supply chain which stretches to East Asia. However, I see these companies benefiting, but more over the longer term, and in the meantime, it is the semiconductor equipment makers which should gain the most as I will show in this thesis.
One way to gain exposure to equipment plays is to invest in the iShares Semiconductor ETF ( SOXX ) which has suffered from a 21% drop in the last year as shown in the chart below.
I start by providing some insights on the CHIPS Act which has now been signed into law, stressing how it will translate into more capital expenses by semiconductor (semis) manufacturers.
The CHIPS Act
The Act should stimulate investment in the semis sector with one example being Micron, which has announced a $40 billion venture to manufacture memory chips, thereby paving the way to increasing U.S. market share from 2% to 10% . To this end, one key part of the legislation is investment tax credits, which can equal 25% for a qualified advanced facility a chip manufacturer invests in. As for Intel, with its $20 billion project foundry project for manufacturing microprocessors in Ohio, it expects to receive funding in 2023 as it follows the application process for CHIPS money.
On the other hand, things are less clear for fabless plays such as Qualcomm (NASDAQ: QCOM ), Advanced Micro Devices (NASDAQ: AMD ), and Nvidia (NASDAQ: NVDA ), who after designing their own chips, rely on contract foundry operators like Taiwan Semiconductor ( TSM ) for the production part. Still, they could benefit from the R&D component of the CHIPS act whereby $13 billion out of the $52 billion has been earmarked for semiconductor research facilities.
Hence, $39 billion (52-13) should go to boosting chip manufacturing in the U.S. Motivated by these subsidies, other manufacturers like GLOBALFOUNDRIES (NASDAQ: GFS ) are also expanding capacity. This is also the case with Samsung Electronics ( SSNLF ) which already produces chips in Texas and TSM which is building a foundry in Arizona.
The chart below shows the quarterly Capex spending of some of the names I just mentioned as well as for Texas Instruments (NASDAQ: TXN ) which produces analog chips. It is setting four plants worth $30 billion . Adding up the amounts just for Micron, Intel, and Texas Instruments, I obtain $90 billion, which signifies that the charts below will see uptrends.
Looking deeper, these billions of dollars of Capex spend will go towards building up manufacturing sites, thereby consuming more steel and concrete. However, for the sites to be operational and produce chips, something more important is required and this is the equipment for manufacturing semiconductors.
Semiconductor Equipment Makers
Going into more detail, there are several private and publicly listed companies that produce chip-making equipment used for lithography, wafer deposition, process diagnostics, assembly, and test systems. One such company which is also held by SOXX is Applied Material (NASDAQ: AMAT ) which makes equipment for ion implantation, rapid thermal processing, and many other purposes.
Furthermore, the ETF clearly differentiates between equipment makers like Applied Materials and the wider semiconductor sector as is shown in the table below. It dedicates 20% of assets to semiconductor equipment and makes sense for those who do not want to fish for individual stocks, and, instead look to benefit from industry strength. For investors, it is important to note that at this stage, it is still too early to deduce which of the equipment makers will benefit the most from the Capex spending to be made for boosting the manufacturing of semis. This makes the ETF option as opposed to individual stocks more alluring.
SOXX Semiconductor Equipment holdings (www.ishares.com)
Breaking down the list of semiconductor equipment, names like KLA Corp (NASDAQ: KLAC ) and Lam Research (NASDAQ: LRCX ) start to appear, but one name which has been in the limelight for some time now is Netherlands' ASML NV (NASDAQ: ASML ) which has been prevented from selling its gear to China's SMIC (Semiconductor Manufacturing International Corp) by the U.S. and Dutch authorities. The company's extreme ultraviolet (EUV) systems enable the production of leading-edge chips and denying China such capability is seen as key by the U.S. authorities in order to maintain competitive advantage as well as being in control of the supply chain for sophisticated electronics.
Looking for alternatives, there is also Invesco PHLX Semiconductor ETF ( SOXQ ) which provides exposure to chip equipment makers, but at a slightly lesser extent than SOXX or at 19%. This is as per my calculation in the table below.
SOXQ Equipment holdings (www.invesco.com)
I had already covered this ETF back in May this year where I found it to be better than SOXX from the value perspective.
Coming back to the theme of this thesis which is exposure to semiconductor equipment, whether it is 20% for SOXX or 19% for SOXQ, this still constitutes around one-fifth of both ETFs' assets, which is low. This is also the case with the VanEck Semiconductor ETF ( SMH ), which provides around 19% of exposure to equipment plays.
Consequently, in the future, as more attention turns to the equipment, these ETFs could possibly include other names like Japan's Tokyo Electron ( TOELY ) in their holdings.
Economic Uncertainties But Better Strategic Perspectives
In the meantime, while the WSTS (World Semiconductor Trade Statistics) predicts strong demand globally with the market expected to grow by 13.9% in 2022, there are some uncertainties.
First, inflation fears appear to be crystallizing mostly in Europe as well as on this side of the Atlantic as central bankers tighten monetary policy in order to bring inflation under control. Second, this is a sector where there is less visibility which may have prompted several customers to order more chips than they actually needed from manufacturers at the end of 2021 and beginning of 2022. This implies that inventory levels may be running high and raises the specter of lower demand, cascading into lower sales by chip companies. There are also rising geopolitical risks in East Asia where TSMC together with other local foundry operators accounts for nearly 60% of the chips consumed in the world today.
In these circumstances, after the initial enthusiasm seen on August 9 when President Biden signed the CHIPS Act, the market has suffered with the tech sector taking a beating, especially after Fed Chairman Jerome Powell confirmed his hawkish outlook on interest rates on Friday 26. Thus, a look at the market performance shows that SOXX underperformed by -5.23%, but looking further, it can be noticed that some semiconductor equipment makers like Entegris ( ENTG ), KLAC, and Applied Materials have been less impacted. This shows that there is likely some optimism around the semis equipment space.
Furthermore, despite the prevailing uncertainty over the short to medium terms, it is unlikely that the drive to boost capacity on American soil will be adversely impacted over the longer term. For this purpose, semiconductors are at the heart of all modern electronics and equip a majority of manufactured products, especially the most sophisticated ones. Equally important, reminiscent of Covid-led supply chain bottlenecks impacting components leading to automobile factories being forced to stop production, it is likely for the authorities to push ahead with the execution part of the CHIPS Act.
In this way, they want to ensure just-in-time availability of key electronics items that are now present in everything from smartphones to airplanes. The unavailability of these has also fueled runaway inflation in the country, but, in addition to the economics, there is the strategic imperative to maintain a competitive advantage over China.
Conclusion
Therefore, even amid an economic slowdown, strategic objectives should prevail, namely in onshoring chip manufacturing, in turn signifying more revenues for equipment makers as they have to satisfy the needs of more foundries being set up domestically. In addition, with Europe also having its own version of the CHIPS Act, demand for chip-making gear should be sustained while chip foundries are erected in various parts of the world in order to resolve the concentration risks in having more than half of the world's production capacity in Taiwan.
Now, with the WSTS being hopeful on the one hand, but with growing risks of an economic slowdown on the other, the question is how to proceed. For this matter, SOXX includes some bright spots like Broadcom (NASDAQ: AVGO ) which has increased its software exposure after the VMWare ( VMW ) acquisition. However, with only 7.98% of exposure to Broadcom and 20% to semiconductor equipment makers, the ETF is not a buy yet.
Finally, for those wishing to invest in individual stocks of chip equipment makers provided in the tables above, it is better to do an in-depth analysis of the financials before investing.
For further details see:
SOXX: Chip Equipment Makers To Benefit More From The CHIPS Act