The biggest company you've never heard of

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If you want to know just how integral semiconductors are to our day-to-day lives simply ask Kanish Chugh's four-year-old son. He now knows all about it, thanks to his dad, ETF Securities' head of distribution.

"He was on his iPad and I was thinking, well, the best way to explain it is 'the semiconductors are the engine of the iPad, to make the iPad work, to make a lot of our personal computers and future technology work'. Well, semiconductors are going to be the real driving force behind that."

From autonomous driving, data centres, to live streaming the very interview you can see below, it's fair to say semiconductors do seem to be in everything, and Chugh believes those who design, build, ship and develop them present an inviting investment opportunity.

In this wire, he offers detail on:

  • The three main types of semiconductor companies (designers; makers, foundries; and supply chain companies)
  • The breadth of their current and future technological applications, or as he puts it," the theme will win, the theme will succeed, the theme is long term"
  • Why this time it's different for those who remember the overvaluations in this sector in the tech-wreck era
  • The value in opting for a 30-stock ETF at the current time versus the risk of single-stock exposure, or stock-picking.

Chugh also elaborates on some of the biggest companies you've heard of in semiconductors, such as TSMC and Nvidia, and one of the biggest companies you might not have: Dutch lithograph makers ASML.

Edited transcript

Can you provide a brief introduction to your new semiconductor ETF (ASX: SEMI)?

I've got a four-year-old son and I was thinking, how do I explain semiconductors to (maybe not a four-year-old) but to someone that may not be aware of how integral they are in our life. 

He was on his iPad and I was thinking, well, the best way to explain it is 'the semiconductors are the engine of the iPad to make the iPad work, to make a lot of our personal computers and future technology work'. Well, semiconductors are going to be the real driving force behind that. 

The ETF is ETF Securities' global semiconductor ETF, and the code is SEMI. And as the name suggests it's quite clear, what it's giving you exposure to. 

But really, the ETF, when you drill down a little bit, it's giving you exposure to the 30 largest companies that are part of the semiconductor industry.

It's also been an area of significant growth. We've actually seen that the index that we're tracking over one year to the end of July has had nearly 55% of growth. So really strong returns as well. Now, within the portfolio, there are a number of different exposures. So as I mentioned, it's 30 stocks, but you get exposure to the biggest names within the semiconductor industry.

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Investment Theme
The fundamentals keeping chips hot

What is the anticipated growth trajectory for this thematic and ETF? 

What we need to really understand is how integral semiconductors are in our day-to-day life. And there's been a lot of focus in recent years because of the chip shortage that we've had. 

Now, when you think about the current usage of semiconductors, whether it's an iPad or any personal electronics, these devices are run through semiconductor chips.

Now, within the semiconductor industry, you have essentially three main buckets. 

1. You have companies that are integrated device manufacturers, so companies that are designing chips and manufacturing them, you have chip manufacturers or what they call foundries. And that's a company like TSMC - Taiwan Semiconductors. 

2. You have then, Fabless. So Fabless are essentially just chip designers. 

3. And then you have companies that are integral to the supply chain and the value chain of semiconductors. These are companies such as ASML and they produce what's called a lithography machine, and they essentially have a monopoly on this particular space.

Now, to create a semiconductor chip, you need to the lithography machine, and ASML is the only provider or producer of such technology. So they essentially really have this foothold, this stranglehold, in the semiconductor space.

How are supply chain shortages impacting companies within your ETF? 

Now, the reason why we've seen such a growth in semiconductors or demand has been due to three main factors. 

One is, as technology has improved on producing smaller chips that can be processing more power. You've seen greater usage across all electronic devices and our demand for electronic devices increasing. 

Think about the invention of the plane. Once it started to develop the technology behind the aeroplane, it allowed for greater connectivity from people around the world and movements of goods. The semiconductor industry is the same. 

From the first semiconductoer chip to where we are now, that technology that's improved upon within that industry has allowed us to have the fastest iPhone, the best laptop, the smart TV that can allow us to stream the Olympics, for example. 
And you look beyond that and say, well, the future technology, the megatrends are really, what's going to be driving semiconductor industry growth.

So our needs and our demands or our wants for greater artificial intelligence, whether that's in agriculture with tractors and using AI and automation within the food and agricultural industry. Or even the home retail market, or even the medical device market in terms of midbody surgery robots. They all require semiconductor chips to power them. 

Whether it's your needs for autonomous driving, self-driving vehicles or even electric vehicles ... again, that's going to be one of the biggest growth factors within semiconductors because they require more chips within those spaces.

When you think about the demand that we've seen, so we've talked about demand from consumer electronics to electric vehicles to future demand, whether it's autonomous driving. 

One thing that's occurred is an increase in demand, especially because of COVID. So, the past two years we've seen this increase and unfortunately the supply of semiconductors wasn't ready for it.

Now, when I talked about Taiwan semiconductors, TSMC, it is one of the largest semiconductor chip manufacturers in the world. 

They cater to around 50% of the semiconductor global chips supply. They are essentially investing hundreds and billions of dollars in the research and development of their foundries. They have the largest foundry, essentially the largest factory that produces semiconductor chips. 

To get a foundry up and running takes many years and many dollars of investment and capital intensity to do that. Now, it's not something that can be switched on straight away. So that's really important to understand, so there's a nudge of capital intensity.

There's the other aspect, which is you have the devices along that value chain that allows for a TSMC, for example, to produce the semiconductor chips - and that's companies like ASML. 

So ASML, I mentioned, produces what's called an EUV lithography machine. Essentially, it allows the ability to put little transistors on microchips. Now, each of the machines that ASML builds cost about USD$130 million. It makes them probably one of the most expensive machines, at a cost per machine basis, in the world.

Now, ASML is known as probably one of the biggest and successful companies that no one's ever heard of, but they're integral to our ability to perform tasks, like this virtual interview. The ASML lithography machine has been crucial and integral to that process, but to just get that technology up and running takes many, many years.

In the recent US trade war between China and President Trump, former president Trump came out and said that we're looking to ban the export of ASML machines to China.

That meant that China started to look at how they could reproduce this technology. What they found ... and this is according to The New York Times, was that it would take them nearly 10 years to get up to speed to the technology that ASML currently has. 

So that research and development spend, that timeline that you have, you have these factors that are basically built into what has created a supply drain on semiconductors. And what we're finding more and more as we look beyond this, is the companies that are involved within the semiconductor industry are the companies that are continually winning and growing. 

It's very much a unique industry, where there are very high barriers to entry.

And a lot of the companies within this space have monopolies or even oligopolies. And it's very much a case of, these are the companies to back. And that's sort of how we looked at it when we were looking to build and bring out this ETF for investors.

What is the global exposure investors get through this ETF?  

I think with the global exposure to this SEMI ETF, it's really interesting. People always have this view technology equals the US. And to some extent, that is the case with this ETF as well. Nearly 60% of this ETF will have US exposure. 

So it's companies like Intel, Qualcomm, Nvidia, who make the graphic processing units or graphic cards. And they're really some of the biggest players in this space. Or companies like Lam Research, for example. 
Now, these are the US companies that feature in the portfolio of the 30 stocks. So SEMI is really 30 stocks, but it is a global space. It's not just the US.

So we talked about TSMC, so Taiwan Semiconductors. Now, they are the biggest company in Taiwan and sort of the champion Taiwanese company. 

And they feature in the portfolio. So you get exposure outside of the US. You also get exposure to other countries like the Netherlands through Dutch company ASML. 

So when we're thinking about the thematics, and it's something that, from where ETF Securities stands in terms of building thematic portfolios is, you need to either have a sector or a country agnostic view or both. And I think that's important. 

So this particular ETF is global in nature, it has exposure to companies in South Korea, Taiwan, the US, Europe. But still, yes, predominantly there will be some major exposure to the US and that's by nature of where a lot of these companies sit and are headquartered.

Are stretched valuations a concern for the ASX:SEMI ETF?

I think it's interesting for a number of reasons. 

Well, one is that a lot of people are concerned due to memories of the dot-com bubble. And yes, there are companies within this particular space that were heavily impacted and were probably the major offenders of the dot-com bubble, like Qualcomm or Intel.

But there are two different periods really when you consider it. 

We're talking about the late nineties when the need for semiconductor chips was very different to the demand that we have now for semiconductor chips, and the position that some of these companies are in. 

So for a lot of these companies, having higher-than-average market valuations may be acceptable for investors. 

And when we look at some of these companies, if I'm talking about TSMC, the PE ratio in July, 2021, was trading at about 34. Now in March 2000, its PE ratio was roughly around 58. Qualcomm, which I mentioned earlier, as one of the worst offenders, they were trading at a PE of about 350, back in March 2000. In July 2021, their PE at this point is around 20. 

So what you're finding is fundamentally, very different positions that the semiconductor industry is in now than what it was 20 years ago.

The other thing to consider is regulation and government support. 

The US Senate has recently approved nearly $250 billion of support for the technology industry. And a lot of that is in chip subsidies because they're finding that obviously there's increased demand for semiconductor chips, they're more expensive. 

They're trying to subsidise some of that cost for their local domestic players to alleviate some of that increased expense. 
Now, you'll find that with that support and policies, that's going to drive the continued growth in this space. 

So you have these multiple different factors that I feel from a valuation side, I think people need to take their blinders off a little bit and say, well, I'm not looking at this industry 20 years ago. This industry has evolved, it's matured. And it's in a very different stage than what it was. And so the valuations argument around what it used to be, or what it is now needs to be sort of considered in that way.

With what we've seen with our ranges thematic ranges, thematics like robotics and automation or battery technology or even technology in general, people need to re-evaluate how they view valuations of certain sectors, especially in sectors that are so capital intensive. 

They're so focused on increased research and development, that they are, and may be perceived to have high valuations than what more blue-chip or traditional sectors could have. 

Why is the ASX: SEMI ETF the best way to get exposure to this thematic? 

There are a few reasons why an ETF, such as SEMI, is one of the best ways to get exposure to this thematic. 

Traditionally, an investor, five or six years ago, looking to get exposed to the semiconductor industry, had very little way to do it. You were either buying an active manager, whether that's a managed fund or an ETF or a LIC that may have some exposure to this area. 

You're either trying to find stock exposure and you buy that overseas. So you're buying Nvidia in the US market. Now that's fine, but there's a single stock risk. Which stock is going to be the best performing from that thematic? 
Is it going to be Nvidia? Is it going to be Intel? Is it going to be Qualcomm? Is it going to be TSMC? Is it going to be ASML? It's really hard to really choose and have to isolate one or two names.

The other side is, do you just say, well, I'm getting abroad exposure by buying in the broad market, whether that's an S&P 500 index, whether that's the Nasdaq-100 index, because invariably you are still getting some exposure to the semiconductor industry by virtue of looking down that path, by going broad. 

What we say to investors when thinking about thematics and thinking about megatrends is if you want a pure play, well, then that's where thematics can help.

So if you really want to focus on the thematic of semiconductors, you don't have to think of it, well, I need to try and choose the winner or the loser because you are buying the theme.

The theme will win, the theme will succeed. The theme is long-term. 

So the semiconductor theme and the thematic of semiconductors is going to be something that will be with us for decades to come. 

As long as we're building and producing innovative technology, semiconductors are going to be at the heart of that, and this industry will be at the heart of that. 

So that's why we really feel that for investors taking an ETF allows for you to diversify your 30 stocks (global stocks as well). As I mentioned, US, Europe, South Korea and Taiwan, these are all countries that you get exposure to. And you're getting exposure to some of the biggest names within this space. 
These are the companies that you want exposure to and you're not having to choose between one or the other. You can just buy one ETF or one basket of stocks, so that gives you everything.

The SEMI ETF is one of the best ways to get exposure to this thematic of semiconductors because we do all the heavy lifting for you as an ETF provider. 

We're licensing this index from Solactive. And this index is representative of the 30 largest companies within the semiconductor industry.

We've spoken about the fact that the semiconductor industry is really dominated by the biggest players because of that high barrier to entry, the research and development costs, etc. And by giving investors an ability to just say, well, I can just buy this theme in one ETF, it alleviates their need to have to go and research different stocks and have to choose. Do I take Nvidia over Lam Research, or Intel over Qualcomm, or TSMC. And to that point, it can be very difficult sometimes to get exposure to some of these names. 

So if you're talking about ASML. ASML produces that lithography machine that we've spoken about, they're listed, and they're a Dutch company. Now, some investors may not be able to, or may consider some of the tax treatments, etc, of investing in European stocks or accessing TSMC stock listing. So we're not investing in an ADR when we're taking exposure to TSMC in this ETF, we're actually investing in the Taiwanese listed stock of TSMC. And again, that can be difficult for the individual investor to do.

What I would say there is for investors that want the purest play. This is why we launched SEMI. It was to give investors an ability to say, well, I just want exposure. 

And I want a concentrated exposure to the biggest and the most successful companies in this industry. And it is a pure-play in that way. 
When we talk about thematics, we talk about megatrends. We often say you're not buying the winner, you're not buying the loser, you're buying the theme. The theme will be what wins in the end. 

Whichever companies are featured as part of that theme, will benefit from the theme being successful. The theme needs to be long-term and semiconductors are not going away. The fact that they're in present technology and they're going to be an emerging technology means that this industry will continue to grow.

Invest in semiconductors: dip into chips

For investors wanting to access this promising sector, the ETFS Semiconductor ETF (ASX: SEMI) provides one solution. SEMI buys the world’s 30 largest semiconductor businesses, spanning from foundries to designers to equipment makers. It is the first global semiconductor ETF to list in Australia. 

It takes a market capitalisation weighted approach, ensuring that the top innovators are well represented. While capping the biggest stocks at 10%.

Register for ETF Securities Semiconductors webinar

ETF Securities will be running a webinar on their new SEMI ETF on 15 September at 5pm. To register, please click here.

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