3 Next-Gen Tech Manufacturing Stocks
It’s official: we’re out of the coronavirus recession. Surprisingly, it lasted only two months, the shortest in American history.
COVID-19 was a stress test to the economy and many industries were surprisingly resilient. On the other hand, the pandemic exposed many of our areas of weakness.
While the virus ravaged American hospitals, healthcare professionals couldn’t source the critical personal protective equipment needed to ensure healthcare workers themselves would not contract COVID-19. Decisions made decades ago led to a less resilient pandemic response.
Another area of weakness that’s been exposed by COVID-19 is our decimated manufacturing base and supply chains. In recent months, shortages of chips have led to many industries—from cars to appliances to even toothbrush manufacturers—grinding to a standstill!
Let’s check in on the stakes of this chip shortage, and why it could be a tailwind for some often overlooked stocks you could be missing in your portfolio.
The Rise of Manufacturing in Asia
American manufacturers began to fall behind other countries in the late 1970s. Japan was the economic story of the 80s, as their automobile and electronics stole market share from the United States.
Japan’s secret: just-in-time (JIT) inventory management. Instead of buying material in bulk, JIT sought to deliver materials only when needed. This breakthrough improved efficiency and helped the country provide cheaper products. The system was quickly incorporated at American companies as well.
Yet JIT still didn’t solve the key issue for American manufacturers: labor costs in developing Asian countries were significantly lower than in the States. The solution was aggressive outsourcing. Companies like Nike were early pioneers and used overseas labor as a competitive advantage to increase profit and win market share
In 1972, President Nixon visited China to further the diplomatic relationship; the United States established full diplomatic relations in 1979 and the country became a manufacturing hotspot for America.
Manufacturing jobs in the United States peaked in 1979 at nearly 20 million employees, nearly 8 million more than exist today, while China became the world’s manufacturing superpower.
Reshoring Tech Manufacturing as a National Imperative
America’s supply chain became optimized for profit, but this came at the expense of resiliency. As the N95 mask shortage during the pandemic proved, America became reliant on the manufacturing output of countries that often don’t share the same economic principles.
Demand for PPE is (hopefully) over, but another conflict is rapidly approaching: the silicon race. And it’s even more important for America’s long-term economic dominance.
China is no longer satisfied with providing low-value assembly and workshop labor. In 2015, President Xi Jinping announced an ambitious plan dubbed Made in China 2025, with the stated goal of making China the No. 1 technology powerhouse.
The key industries for Made in China 2025 include the Internet of Things, robotics, AI/machine learning, and electric vehicles.
Against that backdrop, building out America’s semiconductor manufacturing capacity is a matter of national strategic importance and recent events might have shortened America’s timeline to respond.
A Land Dispute Making Big Tech CEOs Nervous
The biggest front of the race for global technology dominance runs through an island in the Pacific Ocean. Taiwan, or the Republic of China, is only the size of Maryland but it’s making a few of the world’s biggest CEOs queasy.
The island’s economic crown jewel, Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE: TSM), is one of the world’s largest companies due to its dominance as a leading semiconductor foundry (manufacturer) and it’s not alone. In fact, the country manufactures more than half of the world’s chips.
Beijing views Taiwan as a territory owned by China while the island views itself as a sovereign country. Increasingly, tensions are coming to a head and Beijing seems to be on a collision course with Taiwan’s leadership. The United States and Japan have been coordinating military exercises in preparation for possible conflict.
The lack of U.S. semiconductor manufacturing capability along with China’s claims on the world’s semiconductor foundry has Washington nervous.
The United States Senate recently passed the United States Innovation and Competition Act of 2021, with the crown jewel being $52 billion committed to semiconductor manufacturing.
America might be down when it comes to high-technology manufacturing but it’s certainly not out. Here are three companies that will be instrumental in reclaiming America’s position as a top-notch tech manufacturing economy.
1. Intel Corporation isn’t dead
- Intel (NASDAQ:INTC)
- Price: $0 (as of close Aug 24, 2021)
- Market Cap: 218,307,170,000
Let’s get this out of the way: Intel’s stock has seen better days. The semiconductor company was briefly the fourth largest company in the United States as its chips powered most personal computers running Microsoft.
Unlike its Wintel monopoly partner Microsoft, Intel has never regained the highs set in the early 2000s before the tech crash.
These days investors are flocking to fabless chipmakers like NVIDIA, Qualcomm, and AMD (companies that specialize in chip design but hand off the manufacturing to foundries like Taiwan Semiconductor and GlobalFoundries).
Intel, on the other hand, is one of a few chipmakers known as integrated device manufacturers (IDMs) that design, manufacture, and sell their chips.
The upside for IDMs is they control the entire vertically integrated process. The downside for IDMs is their complex operations can come at the expense of being nimble, particularly in the dynamic critical design process. This is what happened to Intel, losing ground to AMD and NVIDIA.
However, the company’s new CEO has an interesting plan to turn what has been considered a weakness into a strength: in addition to announcing a massive $20 billion investment in two Arizona chip plants, Intel announced its intentions to open its manufacturing to third-party designers, essentially becoming a foundry as well.
Intel’s move comes at an opportune time. Increasingly, technology companies like Apple are moving into designing their own chipsets. Last year Intel was on the short end of this development when Apple announced it was no longer using Intel chips in its MacBooks.
Once considered a commoditized process, increasingly U.S. technology companies and the government understand that having geographically diverse foundry suppliers might be the best approach to ensure we maintain our technological edge. What was once considered a weakness might become Intel’s biggest strength.
Intel might not be the growth stock of yesteryear, but neither is it in a death spiral. During the pandemic last year, Intel grew its top line 8% over the prior year.
Simply put, reports of Intel’s demise have been greatly exaggerated and the company could post strong returns from the overall growth in semiconductors and a return to domestic chip manufacturing.
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2. Texas Instruments is an overlooked cash flow machine
- Texas Instruments (NASDAQ:TXN)
- Price: $0 (as of close Aug 24, 2021)
- Market Cap: 173,397,296,753
Texas Instruments is often forgotten when it comes to the semiconductor industry. Like Intel, the company is an IDM that designs and manufactures its own chipsets.
Texas Instruments chips are either analog or embedded functions (think about the 1,500 types of chips that go in the average car), far from the high-profile GPU and AI chips that get Wall Street analysts excited.
Don’t dismiss, however, the importance of the company. Texas Instruments chips will be mission-critical for next-gen applications like the Industrial Internet of Things, smart cities, and self-driving automobiles.
In fact, nearly 60% of Texas Instruments revenue is from the automotive and industrial markets.
Despite being overlooked by pure-play technology investors, Texas Instruments stock has found a receptive audience from income and value investors and shares have advanced 180% versus 100% for the greater S&P 500 in the last five years.
The company has one of the most shareholder-friendly management teams and is laser focused on growing free cash flow and returning it to shareholders via dividends and share buybacks after investing in the company’s manufacturing and chip design to ensure it maintains and grows market share.
Since instituting the free cash flow return policy in 2004, Texas Instruments has grown free cash flow per share 12% every year, repurchased 46% of total shares outstanding, and grown dividends 26% per year!
The company’s revenue growth might have slowed—last year they registered growth of less than 1%—but Texas Instruments is well situated to benefit from the next generation technologies referenced above and will continue to return massive amounts of cash to shareholders.
If the United States is slated to win the battle for next-gen technology, Texas Instruments will play an important role.
3. Applied Materials will benefit from more manufacturing
- Applied Materials (NASDAQ:AMAT)
- Price: $0 (as of close Aug 24, 2021)
- Market Cap: 120,133,630,568
Applied Materials is the best pick-and-shovel play for the growth of the semiconductor manufacturing industry. The opportunity here is massive: you know the future will be dominated by tech-intensive industries powered by silicon.
(Worldwide sales for semiconductors are currently $530 billion with forecasts for the industry to nearly double to $1 trillion by 2030!)
Here’s the deal: global manufacturing capacity will need to ramp up to provide the semiconductors needed to meet demand. Additionally, governments and companies are paying closer attention to where the chips are being manufactured. Simply put, we need more foundries.
Chipmakers are spending billions on these efforts. Intel shocked Wall Street when it announced it had committed to spending $20 billion to build out two new fabrication facilities. (Taiwan Semiconductor Manufacturing has committed nearly $100 billion in the next three years, so it’s likely you’ll see increased spending from all foundries to catch up.)
This is Applied Materials’ opportunity as the company manufactures the critical machines and equipment needed to turn raw materials into finished chipsets.
Applied Materials has been printing chips, both literally and figuratively. With a one-year return of 115%, Applied Materials has quietly been the best-performing mega-cap (over $100 billion) technology stock.
Applied Materials hasn’t disappointed: in the second quarter the company reported revenue growth of 41% and net income growth of 76% through margin increases.
There are certainly risks. The first is that demand for its products is cyclical and heavily dictated by semiconductor demand. Applied Materials could sell off if the company experiences a chip oversupply situation like what happened in 2018.
Additionally, at 33% and 19%, China and Taiwan are a significant part of Applied Materials revenue this quarter and could be impacted in the short-term if there’s a decoupling between the United States and China due to the Taiwan dispute.
Ultimately, these are short-term risks. We’re in a chip super-cycle as demand for car, phone, and data center chips will keep demand for manufacturing capacity high.
While Applied Materials has competitors like Lam Research, the complicated nature of this equipment and knowledge needed to manufacture this equipment is a powerful barrier to entry.
In the long run, Applied Materials has a significant runway for growth equipping chip manufacturers, and this is increasingly a matter of national security. Regardless of what happens in Taiwan, Applied Materials will reward investors for years to come.
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