Increased Semiconductor Demand
While semiconductor-related shares notably retreat from momentum-driven highs, fundamentals are solidifying into an enduring growth cycle, providing discerning investors with long term opportunities.
The COVID-19 global pandemic has impacted every aspect of our lives, from disrupting our daily routines to supply chain disruptions in almost every industry. Semiconductors were no exception, supplies waned while demand increased. Scott Butler, portfolio manager of the TETON Westwood SmallCap Equity Fund and the KEELEY Small-Mid Cap Value Fund, takes a deeper look into semiconductor demand cycles and why we expect capital expenditures to continue to grow.
Global shipments of semiconductors marked a pause at the dawn of the COVID-19 manufacturing disruption. Demand proved resilient during that period of constrained supply, laying the foundation for a new cycle of capacity additions. Prior demand cycles were characterized by steeper volatility (such as 20% peak-to-trough unit declines followed by a span of 50% growth), recent cycles have exhibited more muted declines (higher single digits in the previous year) as the industry matures. Increasingly, subsequent expansion periods have grown larger, tracking towards a doubling of units. The industry has witnessed semiconductor proliferation far beyond personal computer applications to include personal communications, industrial automation, and automotive to name a few. In fact, as with so many other industries, the pandemic only served to accelerate existing trends and the newer categories of optoelectronics and sensors now represent nearly 30% of semiconductor units.
Spending Boom and Strong Demand
With a growing list of new applications laying claim upon future unit demand, the three largest semiconductor manufacturers (Samsung, TSMC, and Intel), who account for over three quarters of industry capital expenditures, have outlined plans for an unprecedented capital outlay over the next three years. We believe this lays the groundwork for stepped-up demand at semiconductor capital equipment suppliers in the near to medium term. Portfolio holdings such as Onto Innovation (makers of inspection and measurement tools) and Advanced Energy Industries (providers of devices converting raw power into a highly refined, controllable state to enable the most sophisticated manufacturing techniques) will be included among the various manufacturing equipment required to outfit these news fabs as they are built. Longer term, as production volumes are ramped, consumables suppliers should also benefit from this markedly higher volume. Here, core portfolio holdings such as Entegris, Inc’s high purity chemicals and gasses, necessary to the manufacturing process, will be required.
Plans for Increased U.S. Production
Amidst this increase in unit demand comes a renewed period of geopolitical tension not experienced for more than a generation. China has declared the semiconductor chip industry a national priority, aiming to double self-sufficiency to 70% within five years. As the US levied sanctions on Chinese access to semiconductor technology in recent years, western governments realized they were woefully undersupplied by domestic production. In fact, Chinese production capacity now exceeds that of North America and is on track to rival both North American and European production combined. Thus, part of the capacity expansion plans by both Intel and TSMC are aimed squarely at the US, with considerations underway in Europe.
Altogether, these trends represent a horizon for semiconductors and equipment suppliers which appear to be the strongest in almost twenty years. While we have already positioned the portfolio to benefit from these trends, the fund’s track record confirms that, historically, broad market volatility provides unique opportunities for active managers to selectively capitalize on long term trends like these. Should these market swoons reoccur, we would continue to employ our value-oriented downside analysis to further position ourselves for long term gains with an attractive cost basis.
As of June 30, 2021, The TETON Westwood SmallCap Equity Fund owned 3.55% of ONTO, 2.60% of AEIS, and 2.42% of ENTG. The KEELEY Small-Mid Cap Value Fund did not own these names.