In the highly cyclical semiconductor business, only a few companies possess the necessary strength to survive and succeed through the constant ups and downs. Although many analysts would support the idea of investing in sector behemoths like Applied Materials, Inc. (NASDAQ:AMAT), in other words, playing safe, I would advocate on taking a closer look at some smaller, less-known companies like ASM International NV (ADR)
(NASDAQ:ASMI) and KLA-Tencor Corporation (NASDAQ:KLAC), which hold strong competitive advantages, mainly due to their cutting-edge and specific product offerings, and thus, stand as highly compelling investment opportunities.
The jewel of the Crown
ASM International NV (ADR) (NASDAQ:ASMI) is a leading provider of manufacturing process and technology solutions for semiconductor producers, carrying out front-and-back-end activities. After selling out a 12% stake of its back-end activities and distributing the gains among shareholders, while implementing a restructuring of its front-end segment, the company looks like a more appealing, even undervalued, investment.
Although it reported strong second-quarter results, a weak guidance for its third-quarter revenue led its stock price to plummet by over 15%, opening an attractive entry point for investors. Strong competition from Applied Materials, Inc. (NASDAQ:AMAT) is expected to continue, but considerable spending on R&D should provide the firm with a competitive advantage over the next few years. As a result, analysts anticipate that ASM International NV (ADR) (NASDAQ:ASMI) will outperform the sector’s EPS performance in the long run, mainly on the back of its cutting-edge front-end tools business.
Moreover, the progressive migration of its front-end manufacturing activities to (the lower-cost market of) Singapore should help ASM International NV (ADR) (NASDAQ:ASMI) improve its margins and returns. In addition, its back-end segment, with low-cost operations in Asia, looks like a hidden gem, for it remains consistently profitable, returning industry leading results.
Trading at a third of the industry average in relation to its sales and about half the mean in relation to its consensus earnings, this stock looks quite undervalued. Moreover, a 1.7% dividend yield makes the wait worthwhile. I´d say buy and hold, you will probably not regret it.
Goliath is not so agile
Applied Materials, Inc. (NASDAQ:AMAT) is a leading provider of manufacturing equipment, services, and software for the semiconductor industry, among others (including the solar photovoltaic and flat panel display industries). With almost ten times the market capitalization of ASM International NV (ADR) (NASDAQ:ASMI), the competition it poses is considerably strong. Its scale, broad product offering, and strong brand name provide it with a wide economic moat, allowing it to successfully compete in almost every segment of the industry. Moreover, hefty R&D investments keep the firm ahead of its competition, while continuous cost-control initiatives and increasing synergies make its prices more appealing.
However, I consider that Applied Materials, Inc. (NASDAQ:AMAT) is not an investment as attractive as ASM International NV (ADR) (NASDAQ:ASMI), even though analysts expect it to outperform the broader sector in terms of EPS growth in the long run.
For starters, the width of its product offering can be seen as a pro, but also as a con. Since many of its competitors specialize in particular products, Applied Materials, Inc. (NASDAQ:AMAT) runs disadvantaged in many of its end-markets, while smaller firms offer the best products in these particular niches. Furthermore, the cyclicality of the semiconductor business, a high fixed-cost structure, and the recent weakness in its solar equipment segment could strongly impact its future results. Finally, its valuation at 25 times consensus earnings and a PEG ratio of 2.8, both about double the industry averages, lead me to advocate on holding on this stock for now.
A closer inspection
KLA-Tencor Corporation (NASDAQ:KLAC) is another interesting investment option in the semiconductor equipment business. With a market cap of almost $10 billion, it stands in between ASM and Applied Materials, Inc. (NASDAQ:AMAT). However, holding a leading spot in the process diagnostic and control (PDC) market, the company offers margins and returns which are among the best in the industry.