Not your father's chip industry

Following a recent transformation, the semiconductor industry features high-quality companies being driven by meaningful, long-term secular-growth trends, says Fidelity's Vince Montemaggiore.

• Demand for semiconductors should grow substantially in the coming decade, boosted by the industry's emergence from a recent downturn and long-term secular-growth trends around digitization, according to Fidelity Portfolio Manager Vince Montemaggiore.
• "I see a much broader set of drivers for chipmakers and other semiconductor businesses, including high-performance computing, data storage, electric vehicles, Internet of Things and artificial intelligence, to name just a handful," explains Montemaggiore, who manages Fidelity Advisor^® Overseas Fund.
• He notes that historically semiconductor manufacturers were perceived to be low-quality companies susceptible to considerable cyclical volatility, and while these dynamics are still at play in certain segments of the industry — especially memory — today's demand drivers are generally much more broad-based.
• "In fact, the performance of chipmaking stocks used to be overwhelmingly driven by trends in consumer electronics and was plagued by low visibility, which inevitably led to too much capacity at the top of the cycle and slashing prices once it turned," he says.
• Those dynamics are decidedly out of sync with the investment approach Montemaggiore follows in managing the fund. He favors firms with a unique business model that can generate a sustainably high return on capital through a full business cycle and that trade at a discount to their intrinsic, or fair, value.
• The quality of companies in the semiconductor value chain have dramatically improved over the years, he says, partly due to consolidation and partly due to the fact that only a few companies have the technical capability to provide the equipment necessary to make more-advanced products.
• As an international investor, Montemaggiore points to Europe, Japan and Taiwan as home to some of the highest-quality semiconductor and semi-cap equipment firms in the world, with many boasting excellent long-term growth prospects.
• He also notes that many of these businesses operate within a monopolistic or duopolistic industry structure, are mission-critical to their customers and have extremely high switching costs.
• "Recent supply-chain congestion, coupled with East-West geopolitical tension, have spurred a movement to build more-robust domestic chip-production capabilities in both the U.S. and Europe," Montemaggiore contends. "This should lead to a push for technological sovereignty and a subsequent capacity shift, resulting in a multiyear boost among equipment providers."
• The fund counts several high-quality semiconductor companies among its overweight positions as of April 30, including ASML Holding, Taiwan Semiconductor Manufacturing, ASM International, Infineon Technologies, Tokyo Electron and Renesas Electronics.
• Montemaggiore is particularly enthusiastic about ASML and ASM International. He feels the stocks have benefited as investors switched focus from the cycle to strong, multiyear secular drivers, especially the increasing use of extreme ultraviolet photolithography (ASML) and atomic layer deposition (ASM), critical technologies allowing Moore's Law — the guiding principle of progress in the semiconductor industry — to continue.
• Looking ahead, he believes ASM and other semiconductor-related holdings are well-positioned structurally in the medium term, and also cyclically in the near term, as the industry recovers from a downcycle in 2023.