If you’re looking for a sure thing in tech stocks these days, it seems you could do worse than shares of a couple of the biggest chip equipment makers, the companies that provide the tools to Intel and others to fabricate semiconductors.
That’s the conventional wisdom, at least. But you may want to pause to consider whether following the crowd is best. There are other places to find excellent tech companies. Three great picks to consider are automotive-parts supplier Aptiv (ticker: APTV), European semiconductor maker STMicroelectronics (STM), and Japanese motor maker Nidec (6594.Japan).
Last week, shares of Lam Research (LRCX) and KLA-Tencor (KLAC), among the top chip equipment vendors, actually saw their shares decline slightly despite reporting healthy results. Both of these companies have been increasingly levered to one class of chips: memory chips, both DRAM and NAND. They boosted their stocks tremendously last year, but debate now is turning to whether the bubble is going to burst this year.
Furious demand for memory chips made Lam’s and KLA’s tools incredibly valuable. Lam stock rose by 74% in 2017, not only trouncing the Standard & Poor’s 500 index’s 19% return but almost doubling the return of the whole chip market, as measured by the benchmark Philadelphia Semiconductor Index’s 38% return. KLA, with somewhat less exposure to memory, had a less stellar but still perfectly respectable 34% return.
The stocks are merely tracking the major indexes this year, and last week’s waffling indicates that investors are re-examining their enthusiasm. The soul-searching is nicely encapsulated by Robert Maire of Semiconductor Advisors, who noted that tools for making memory chips made up 77% of Lam’s total shipments in the latest quarter and 71% of KLA’s.
“Given historical volatility of memory spending,” which comes and goes in waves, that fact “remains both scary and intoxicating,” he wrote.
DO YOU BET ON SCARY, as in, memory chips cooling and that business declining? Or do you bet that the market will rage on in 2018?
For the bull case, Craig Ellis of B. Riley FBR, who follows these stocks, last week wrote that things in memory land look better than people realize. Reviewing several data points from chip companies—better-than-expected sales of server computers by Intel (INTC) and continued demand for graphics chips from Nvidia (NVDA), which in turn require their own memory circuitry—Ellis says there is “healthy and rising near- and long-term NAND spending pressure,” referring to the buying of tools to make the flash memory chips that power so many devices today.
Almost everyone would agree, given that just about every analyst covering Lam has the equivalent of a Buy rating on its stock. It’s a little less skewed in the case of KLA, but also mostly tilted to bullishness.
The bear case for Lam is made by lonely Abhinav Davuluri of Morningstar, who wrote that it’s not demand for memory chips you should worry about, but supply. It has been hard to make these chips, and that has increased the need for tools. But things get easier later this year, as Intel, Micron Technology (MU), Samsung Electronics (005930.Korea), Western Digital (WDC), and others scale the learning curve. As chip makers start to achieve more finished parts from the tools they already own, they won’t need to buy as much new gear, Davuluri contends.
Indeed, revenue growth at Lam is set to cool from the torrid 35% rate that Wall Street projects for the fiscal year ending this June to something more like 5% next fiscal year. Davuluri actually argues that KLA is the better buy, as more of the kinds of tools it sells will be helped by things outside the memory-chip market.
If you want to buck the crowd, you could take a pass on both these stocks in a couple of different ways. One is to buy the stocks of their competitors, Applied Materials (AMAT) and ASML Holding (ASML), both of which were picks of this column last year. They both did well, rising almost 70%. Or you can go much further afield, and make some bets on the less-well-known names that nevertheless have a hand in multiple important tech trends.
Aptiv is an interesting way to play the advent of self-driving cars. Returning from the Detroit Auto Show two weeks ago, the big trade event of the industry, Cowen’s Jeffrey Osborne wrote that Aptiv is more and more putting together a portfolio of both hardware and software that produces not only ADAS, the basic driver-assistance function, but the car’s powertrain and other functions. He sees that comprehensive quality giving Aptiv an edge over other suppliers.
STMicroelectronics is a behemoth and poorly understood by the average investor. Among its many abilities is an incredible assortment of chips that can be used in 3-D sensing, a catchall phrase that includes both Apple’s (AAPL) Face ID facial-recognition technology in the iPhone X and various forms of augmented reality, in which computers can sense the world around them. STMicro may have big opportunities as AR, as it’s known, proliferates in coming years.
Lastly, Nidec sells an array of motors into a plethora of markets. Among other things, they create “haptic” feedback in the iPhone, the tactile feedback that gives the illusion of the display having mechanical give and take when you press on something. Motors will be increasingly important in markets for drones, for one, where smaller, lighter motors can make possible more nimble drones that burn less fuel while carrying greater payloads.
All three stocks have had good runs in the past 12 months, so they are by no means undiscovered. Consider them representative of a way to ride tech trends while avoiding plunking all of your money into a craze for memory chips that at some point must run its course.
