Motley Fool Hidden Gems Investing - Cashing In On Chips

Episode Date: July 20, 2023

The semiconductor industry may have hit bottom based on some recent earnings, but is it only up from here? (00:12) Tim Beyers and Deidre Woollard discuss: The challenges with standing up semiconductor factories in the U.S. The different types of chips Taiwan Semiconductor produces and what companies use them. The restrictions that impact ASML. (17:49) Kirsten Guerra and Deidre Woollard explore what solar inverters do and which companies are profiting from this growing niche. Companies discussed:  ASML, TSM, NVDA, AAPL, ENPH, SEDG Host: Deidre Woollard Guests: Tim Beyers, Kirsten Guerra Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. The chips are still down in the near term, but are good times coming? Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst Tim Byers. How are you today, Tim? Fully caffeinated, ready to go, Deidre. Love to hear it. I wanted to talk to you today about semiconductors, kicking off with Taiwan Semi. Revenue was down 10%, net income down 23%, but that wasn't a surprise. I mean, we've seen all long slow sales for phones, PCs, sort of the other side of that

pandemic boom. It seems like there's hope on the horizon though, right? I think so. And let's be clear. I mean, this is a cyclical business and there have been macro headwinds. And so in the call, the Taiwan Semiconductor leadership team, particularly C.C. Wei, the chief executive officer, did acknowledge that there were macro headwinds, that they have competition here in North America in particular for new fabrication facilities that were standing up here on U.S. shores. And there is the very distinct possibility, it looks like Taiwan Semi is saying that the facilities that they were going to build out in Arizona are at least on hold for the time being. So if all of that is true, yeah, of course, there's going to be a short-term dip in revenue

and profit margin while we adjust to the semiconductor cycle. But Taiwan Semiconductor has been at this for a really long time. They know how to do this. They are investing back into their business. They are investing into newer, smaller process technology. And most importantly, Deidre, CC Way did commit to, despite all of these short-term challenges that we're seeing because of things like dips in smartphone sales and things like that, they still believe that over the long term, 15% to 20% compound annual revenue growth for the next several years is still to come. They are not backing away from that target that they made in 2022, Deidre. So yeah, this is not great at the moment because of just where we are in the semiconductor cycle.

But I mean, no one should question the long-term health of Taiwan Semiconductor based on these results. Oh yeah, absolutely not. You mentioned the issues they're having with building that facility in Arizona. I thought that was kind of interesting. You know, they've got this lack of skilled workers to build the equipment. They have to bring in workers from Taiwan, which is pushing the timeline out for that factory. I think it underlines this sort of broader issue, though, that I'm thinking about with the semiconductor growth in the U.S. is the trained workers, not just for the factories, building the factories, but for the factories down the road. What are you feeling about the forecast for how fast the U.S. can get up to

speed? To me, I start to think maybe it's a little unrealistic. What do you think? Well, I think that's right. And I think this is part of the reason that we had the CHIPS legislation from, gosh, I mean, is it two years ago now? I'm going to get my timeline wrong. I feel like it's a year to two years ago. But that legislation is particularly designed to build up infrastructure that does not presently exist for chip manufacturing here on U.S. shores. And that includes, to the point you just made, Deidre, a skilled workforce, a skilled workforce that knows how to construct and work inside a fabrication facility, which is, I mean, that's very specialized work. You're talking about clean rooms. You're talking about,

you know, ultraviolet equipment. You're talking about really interesting levels of manufacturing process that we're just not used to here in the United States. We just haven't done it at the scale that they do it in Taiwan. So yes, we do have to bring in that expertise from overseas, but we definitely want to grow it up here in the U.S. as well. And I mean, look, there are really incredible engineering schools in the United States. I mean, let's get some engineering training at those schools here in the U.S. I think some of the legislation we've seen is aimed to do some of that, Deidre, but boy, do we have a long way to go to actually build up that skill set. Yeah, yeah, absolutely. There was some legislation recently related to

Columbus, Ohio and what they're doing with training workers there. I think it's going to be an ongoing problem. Well, I want to get a little bit deeper into the weeds with Taiwan, just because this is the biggest chip maker in the world. And I understand so little of it, but maybe you can help with that because I know there's the different nanometers, right? So looking at the results, the five nanometer and the seven nanometer right now, they're about 53% of the revenue, but then there's the three nanometer, which the rumor has it might be used in the new iPhone coming out, maybe being announced in September. How do we understand this stuff from a very broad explain it to me like i'm five kind of way okay so here's the thing

if you want to have if if if you were if you were five and you were you were digging you know the you know if i could get you a ball that would you know if you threw it it would bounce higher and go farther because the amount of bounce that we can pack into that super ball is just getting better like yeah you know what the seven nanometer ball is pretty good i can bounce that thing up to you know the top of the garage and the five nanometer is really awesome because i can bounce that thing up to the chimney but but that three nanometer that thing's going into my neighbor's yard i can start like you know making cats go crazy down down the block so yeah yeah get me the three nanometer ball and and the point here is that once you start with lower scale

you know smaller scale what you can do is pack more transistors more compute power into a smaller format and the smaller the chip the the less energy potentially like you you end up using a lot of energy when you have a lot of chips packed together in a tight space that generates heat and that becomes problematic but once you get down to smaller scale you create a much more efficient and particularly a more power efficient chip but with the same compute dynamics that's really useful and these are really important like you see you mentioned the iphone and the newer iphones you absolutely want power efficient chips that do more and have more compute power in the format of a smartphone because you want your smartphone to not chew up the battery

within 30 minutes you want it to be very power efficient so you want that chip to be small you want it to pack a you know a real punch in terms of compute power but you want it to be extremely power efficient so that apple can run ads that say hey you know we have 15 hour battery life or 24-hour battery life on the new iPhone. And those small form factor chips are part of the reason you can get that. That was a really great explanation. So with these different nanometer sizes, is there more complexity to making them as it goes along? There's no question. Because once you get down to three nanometers and lower, I mean, you are talking you know microscopic upon microscopic types of um you know lithography here and you are etching

onto the smallest of the smallest you know silicon particles here so yeah it is incredibly complex this is why fabrication facilities are so complex to build it's why the particles are so sensitive and so you have things like like clean rooms this is just hard this is really hard stuff to do the equipment is expensive the facilities are expensive and the expertise to run them is incredibly um sophisticated you know it's hard to get and it's hard to train and and once you get to do it it it really does command a premium so the reason the taiwan semiconductor has grown in importance over time is because this stuff is hard and they know how to do it better than anybody else in the world because they've been doing it since the 1980s. Well, we talked about

how important they are for Apple. Another company that they're really important for is NVIDIA. NVIDIA's ambitious forecasts for AI have sort of galvanized the stock market. None of that happens without Taiwan Semi. And on the earnings call, there was a little bit of a question about, you know, is Taiwan Semi kind of giving up too much value in the AI chain? You know, C.C. Wei, the CEO that you mentioned earlier, he kind of laughed it off. He said, oh, we're happy to see, you know, our customers doing so well. If they do well, we do well. Is there a way for them to extract more value from AI? Oh, I'm sure there is, but they shouldn't do it. Okay. Why? You do not want to get into the business of competing with your customers because you don't

want to give somebody else an excuse to say like, you know what, maybe we should band together and start building our own fabrication facilities. Maybe we should do that. You just don't want to get into, you don't want to give somebody an excuse to do that because that's what Intel has been doing for years. And Taiwan Semiconductor started showing the industry like, look, we are switzerland this is all we do we are great at this you don't have to do anything just send us your chip designs do what you do best and we'll do the other stuff and that has been a great sales pitch for 40 plus years like why do you want to screw with that i get that you might be able to extract some value here and maybe because of really custom taiwan semiconductor process

you could build an AI chip that has TSM baked in secret sauce because of the secret sauce of a very private manufacturing process that they could generate and stand up in their own factories. But no, I mean, I just, I wouldn't do it. I think the risks are just too much. And here's the thing, when nvidia needs its chips and it needs them fast and it needs to meet demand guess who gets to charge a premium for moving to the front of the line tsm gets to do that they get margin on this so i mean he is right cc way is so right about this like if when it's a win-win-win for you and your customer and the overall customer, the profits are going to come. They make plenty of profit. This is a company that's been generating cash flow. I'll put it this way, Deidre. I've

been collecting dividends on Taiwan Semiconductor stock since 2006. I am very happy to continue to do so. They don't need to do anything in order to keep distributing those dividends to me. So yeah, keep it up. I'm happy. It's not broke. Don't try to fix it. Exactly. Let's talk a little bit about ASML. They reported yesterday, it's sort of the originator of things, because they're the Netherlands-based lithography maker. Good quarter for them, 38% increase in profit. They've got that monopoly on the chip-making machines. They are feeling a little bit of the semiconductor slump that we talked about, the sort of the cyclical thing. I thought it was interesting on the earnings call

that they didn't give guidance for 2024. I think nearly every analyst tried to ask them the question in a slightly different way. And the CEO did not budge, which I always like it when a CEO is stubborn. But how should we interpret that? I think you should interpret it that this is a conservative Dutch company that is not going to try to tell you something that is either untrue or i mean they're not they're just not going to try to fake it um they and you know what i appreciate that um they don't have enough visibility into you know into that far ahead so they're not going to try to pretend that they do have that kind of visibility now what they're saying is that they still have a robust backlog for their extreme ultraviolet lithography machines.

They have a very rich backlog that is well above 30 billion euro. That's not changing. And demand for their machines is also likely not changing. And as there are more fabrication facilities stood up around the world. There will continue to be demand for those machines. But there are also some other macroeconomic factors, and there are political factors. I mean, they did say also that China is a very important market for, historically, those EUV machines, which are their most advanced machines. And there aren't as many of those going to China anymore. There are import and export restrictions. And that's problematic. That sort of cuts them off at the knees a little bit here. And we don't know when that ends. In the meantime, they have some

older machines, those deep lithography machines that are still deep ultraviolet, I should say. So for some older chips, some larger form factor chips. And you know what? They can sell those into you know, certain customers in China. So, yeah, they're not completely cut off. But due to economies, inflation, some of these, you know, import restrictions, things are a little bit squishier. And you know what? I appreciate them not guessing when none of us really knows. Yeah, I think that's true. So there is that concern with the DUVs. So I guess those ones make the memory chips. What is it that the EUVs do and why is that important? Well, we just talked about the super balls, right? So those three nanometer super balls,

you need those EUV machines to make the three nanometer super balls. So um they are what you use for making the most um advanced chips they do the most precise etching onto the smallest form factors they they're just a a brilliant design and up to this point there's really nothing like them and so you need them if you want to make if you want to compete in areas where Taiwan Semiconductor, for example, is really generating huge amounts of revenue. So making tiny but really powerful chips for smartphones and making tiny but really powerful chips for high performance systems that drive things like AI that go into data centers, you need a uv machines and so like i said that backlog is big and it's probably only going to

get bigger deidre yeah yeah absolutely well thank you for breaking this all down for me today really appreciate it thanks deidre it's hot out there let's talk solar energy and how we can take advantage of the sun I sat down with Kirsten Guerra to break down the world of solar inverters and the two companies dominating the market. You've done some research recently on the world of solar inverters and some of the companies that make them. Let's start first with what a solar inverter does because I know about solar panels, but I know nothing about solar inverters. Right. Always happy to talk solar. So yeah, what's an inverter? Basically, when sunlight reaches us and our solar

panels. It arrives in the form of direct current, or maybe you've heard of it as DC. But nearly every country's electrical system across the world uses energy in the form of alternating current, or AC. And so an inverter is the component required of every solar array that makes that conversion happen. And so in a way, that's it. It's actually a super simple concept. But to complicate things a little bit further, until recent years, what's been most popular are called central and string inverters. And this is where you have a whole group of solar panels. So just like imagine 10 to 12 solar panels.

They all collect that DC energy. And then, you know, that's transported through a wire and that energy moves along to a singular shared inverter where all of that conversion happens in one place. More popular now for residential and small business installations at least are what are called microinverters, which are a lot like what they sound.

They're smaller inverters, but there's more of them. they are attached to each individual solar panel. And so the DC to AC conversion there happens right at the panel level. And so I'm sure we'll talk more about what that means for the businesses in this space, but that's kind of the basics on what an inverter does. Cool. Thank you. So it sounds like if you have the microinverters versus the other inverters, you get to kind of tweak things a little more easily. Maybe you get better capacity or things like that. So one of the big advantages of that microinverter sort of setup is that you get individualized. You can see into exactly which panels are producing. For example,

that's one major thing. And so if one panel is shaded in a serially wired traditional inverter array, when that one panel is shaded, you're going to see a drastically reduced overall performance from the entire array because it's limited by that singular panel. But when you have microinverters, you get that visibility into the fact that one of those panels is under-contributing, and then you can go in and sort of fix that issue and get more from the overall array. So over the long term, you get a lot more out of your array. So even though they cost a little bit more up front, it's worthwhile in the end. Makes sense. All about bang for your buck.

One of the things you referred to in your research was the importance of the installers. So they're sort of, you know, they're kind of the gatekeepers. And it sounds like they have their preferences, which is kind of an impact on the inverter market. So if they like your product, that's probably really great news. But if they don't or if another company becomes more attractive, is there a risk there? Yeah, for sure. Installers are very key players to understand this market. If you imagine yourself as a homeowner and you're trying to make this decision for solar,

you have to realize this is a very, very low frequency, low familiarity, high commitment type purchase. So you really are trusting in the expertise of the installers that are helping you. So to get a lay of the land here, companies like Enphase or SolarEdge create the inverters themselves or like a JNCO solar creates the solar cells and panels. But the installers, like a Sunrun, for example, are actually the people that come into your home or onto your home and they're physically installing those solar systems. And they also often have kind of an ongoing maintenance relationship for if anything goes wrong with that system. That's great when they love your product, but when they do, it's really important to— that's an advantage you really want to remain very focused on maintaining because those relationships are built over very long periods of time.

In phase SolarEdge, they've been working at this. So you have to keep producing at a certain quality level and continuously earn that trust because it can be lost very quickly. Interesting. Let's talk a little bit about the markets because I feel like in solar, California has been the leader, right? Biggest market for solar. And part of that is the credits that you get from the households with the solar panels. You get the credits back from the utilities.

But there's a little thing that's happening here about reforming net metering rates. It's happening in California. It's starting to happen in other states. How does this impact the solar inverter companies? Yeah, so this can be a big concern, especially at least in the short term. So when you install a solar array on your home or small business, you typically think in terms of a payback period, which is like I have to pay a considerable amount of money up front. But how long will it take me to recoup all of that cost in energy savings before I start directly benefiting from that array? So when a state or a country changes the amount that they will pay those solar owners for the electricity they generate with their solar arrays, which is what we typically call their net metering rate,

When they change that, as California did this April, that totally changes that equation for payback period in how people decide whether they want to install an array or not. So when it changes, it can definitely be a shock to the local solar industry. And especially now, when you couple that with high interest rates, that adds just another financial barrier to considering new installations. But over time, markets adjust. When you lower net metering rates, that typically creates less incentive for the homeowner to sell off all their energy back to the grid, but it creates more incentive to add battery storage to the system. So for example, that's what has happened in Germany in the past, lowered net metering rates. And as a result, battery attachment rates in Germany today are over 90%. So there's two main players here. You've got SolarEdge and Enphase that you

mentioned. What's the core difference between these two? So both Enphase and SolarEdge kind of play in that microinverter space I described. So Enphase really deals with true microinverters as I described them. SolarEdge is what they sell, they call power optimizers, which are also individually placed per panel but they still rely on aggregating and converting energy with a more centralized string inverter so it with the power optimizer route you still get that visibility into which panels are under contributing and things like that but the the conversion is actually still done in a more centralized place and so that does still leave solar edge technology open to a single point of failure if the inverter itself fails that's going

to be an immediate maintenance issue, right? Another major difference between these two businesses is that Enphase, for Enphase, 76% of their revenue comes from the U.S. And for SolarEdge, 36% of their revenue comes from the U.S. So SolarEdge has far more of an international presence. Enphase, of course, is trying to push further into the international market. But today, that is a major difference between the two. Enphase is more reliant on the U.S. markets. And then just a similarity between both of the businesses, in addition to kind of the microinverter approach, is that they are also both in backup batteries and EV chargers now. So they're both really trying to be the complete home energy management solution in this space.

That's the part I'm really interested in is battery storage, because we're recording this and it is really hot out. And solar is big, but getting bigger. And this battery storage thing, we're having power outages, rolling blackouts, things like that. It's still a really tiny part of these businesses, but how big could it get? Yeah, it could really be significant. Like I mentioned earlier that Germany has an attachment rate of 90%. So that's 90% of all home solar installations also have a battery attached as part of that system. Since Enphase and SolarEdge both added batteries to their product lineups, the immediate uptake has been low, but I would expect demand to grow considerably over time, in part due to the incentives of the changes in those

metering rates that I mentioned. So like in California, now that they've lowered metering rates considerably, the way that that has manifested in the battery market is that now, if you're a California resident and thinking about solar, from before, your payback rate, your expected payback rate to install solar has nearly tripled. But if you attach a battery as part of your system instead, the expected payback period only doubles. Now, obviously, that's still a big change. And it's why there's been a slowdown in new installations for the short term again. But it is between tripling your payback period and only doubling it, obviously one of those is a better opportunity. So there is still a strong economic incentive in favor of battery

installation over time. Interesting. Yeah, definitely something to watch. So you've been researching Enphase. Why do you like it as an opportunity as an investment right now? For Enphase specifically, all those changes in California have stirred a lot of fear over what this means for the solar market. And for Enphase, I have estimated California to be around 25% of their revenues. So to be clear, fear is totally founded here. That's a considerable chunk of their revenues that's being called into question. But I think that that fear is very overblown. It's out of proportion.

In the short term, yes, this creates a tough market for Enphase. But we really care about the long term here, right? And so a solar, another way to think about this is that solar officially became the cheapest source of energy in 2020. And so to me, that means that with every new catalyst we see in the energy sector, every time something happens to make a region reconsider their energy independence, solar increasingly will become the answer. And so that's a huge runway for solar.

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow.