Baby got Backlog!

Semi Capital Equipment - Not Sure I Have Seen This Before!

The following article is based on my over twenty years of studying the semiconductor industry for investment purposes, these are my observations.

Historically, the semiconductor industry has been marked by extreme boom and bust cycles. The good times would see strong demand, pricing power, and low inventories, the bust times would display the opposite. Recently, due to the increasing utilization of semis in all aspects of our lives, these cycles have become more muted. Fewer extremes in terms of feast or famine within the industry. Now, that is not to say that the sector is immune from macro demand forces, quite the contrary, we are currently in the midst of a downturn, in my opinion. It is my observation that select companies that enable the manufacturing of semiconductors are in a uniquely favorable position even within a broader downtrend for the industry.

The reasons for the enviable position that many semicapital equipment companies find themselves in are multifold but can be slumped up by simple supply/demand dynamics with a logistical bonus being factored in. You are well aware that semiconductors are increasingly pervasive in our economies. The one factor you may not be aware of but is very significant is that the number of chips per unit keeps climbing. If we take EVs as an example, as they become more complex they require more semiconductors per vehicle than just a couple of years ago. Semiconductor companies want to win as much of this business as possible for their company and therefore must have the most competitive chips on the market. In order to stay highly competitive, semiconductor manufacturers must have leading-edge capabilities and therefore spend on the latest gadgets even though demand for their products is waning.

There is a new significant wrinkle being added to the industry; deglobalization. Now we will see China, the U.S.A., and other nations make semiconductor manufacturing a local priority given these nations want to depend less on outside nations for critical parts of their supply chain. What does this mean? New customers for semicapital equipment companies! Now, it's very possible that at a time when most semicapital companies are still working off elevated backlogs from Covid-related activity, they may very well start to see their backlogs rise again headed into 2024 as construction for new plants gets underway.

If we take a look at Advanced Energy’s (AEIS) latest quarterly trends (below) it seems quite likely they will be able to work their backlog down towards historic norms by late 2023 given the current downturn in the semiconductor industry. But my guess is that backlog will reflate again as legacy customers come back to ordering more equipment along with the new manufacturing facilities. The thought here is that semicapital equipment companies may in fact fare much in 2023 in terms of stock performance versus semiconductor companies.

All this increased manufacturing for semis could easily lead to a glut down the road, but that looks more like a 2025 or 2026 problem in our opinion.

Sincerely,

Frank & the Grinnell Capital team

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Advisory services are offered through Grinnell Capital, LLC, a Utah Investment Advisor. This information is a general publication that reflects our opinion and is not a specific recommendation to any one individual. You must consult your own broker or investment adviser for investment advice.

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