Motley Fool Hidden Gems Investing - Reminder: The Chip Biz is Cyclical

Episode Date: April 17, 2024

The boom is on for chip buyers and sellers, but demand is lighter further up the supply chain. And United results showing the skies look friendly for airline stocks.  (00:21) Tim Beyers and Dylan Lewis discuss: - Why ASML’s earnings show a slowdown in investment in chip manufacturing. - United Airlines’ strong quarterly results, and how the airline is handling fleet issues caused by Boeing. - What to watch from enterprise software companies as they report later in earnings season. (15:19) Deidre Woollard chats up with Steven Jacobs, the president of online commercial real estate exchange Ten-X, about who is actually buying office buildings right now? Companies discussed: ASML, UAL, BA Host: Dylan Lewis Guests: Tim Beyers, Deidre Woollard, Steven Jacobs Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Dylan Lewis. The skies continue to be friendly for airline stocks. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst, Tim Beyers. Tim, thanks for joining me. Tim Beyers. Thanks, Dylan. Fully caffeinated, Ready to go? Love it, because we've got a lot to hit today. We're going to be checking in on travel trends and Europe's largest company. Why don't we start there? Europe's largest company. We have some fresh results from Dutch firm ASML. They are, Tim, essentially the global supplier

of the machines that the chip makers need to print designs onto chips. It is very well documented that the chip business is doing very well right now, but upstream, on the machine supplier side, it seems like results are a little bit lumpier. They are lumpier. There's an open question about this. With overall revenue down 22% year over year for these ultraviolet equipment, ultraviolet lithography, which is what extreme ultraviolet lithography, to be specific, this is an EUV device. They do lots of different things that are involved in the very basics and the very beginnings of chipmaking, literally etching the circuits onto silicon. That's what an EUV machine will do at the microscopic level here. These are very expensive machines.

They only sell either the dozens or hundreds of them in a particular quarter. This particular quarter, I believe they sold 66, which is down from a little over 110 a year ago. So, yeah, not as much demand at the moment here, Dylan. That could be because capacity planning in the semiconductor business is months ahead. This is a roadmap business, where a chipmaker will tell you the generation of chip that is coming within the next several years. They're planning way, way in advance. In order to meet that capacity, as you go back through the supply chain, the demand for, say, an EUV machine from ASML, that order is to satisfy demand that's coming in 18 months, two years, three years. What you're essentially seeing here,

if I had to spitball it, and nobody has a crystal ball here, Dylan, but if I had to spitball it, like we may see a little bit of that cliff that we've been talking about in terms of, hey, we've got enough AI hardware now. Let's hit some pauses here. So, like, the existing chips we have now, yeah, they're just going to keep selling. But give it a couple of years, maybe 18 months, and will we need as much AI-driven hardware? The answer to that is probably no, not as much. Right? So, that is one of those things that maybe we can read into these results. I think we were all expecting some level of moderation here. I think just even earnings expectations for the business, we're not going to be expecting

a massive growth clip. But as you noted, sales down 20%, I think net income down about 40%. We have seen this very business a year ago go through similar dips in orders and in their top-line revenue recognition. Is this just kind of the nature of the beast here, Tim? It is a little bit. I mean, it's a cyclical business. It's more cyclical in this side of the market because the units that get sold are just, I mean, again, you're talking about dozens of machines, maybe 100 to 150 machines in a single quarter. And this is for a worldwide business. So, going to foundries, these semiconductor-making factories around the world, there's not huge volume in this business. So, even though there's huge volumes in actual

chips sold, the business of making chips at this level is just not a high-volume business, Dylan. So, it's going to have a bit more fits and starts than the rest of the value chain when it comes to chipmaking. I want to dig into some of the specific trends here. We are noting that, if you take the global view, roughly half of ASML sales went to China. We have seen some growth in some of the other regions moderate a little bit. Is that different regions catching up to different levels of investment? Or what do you see happening there? That is very difficult to say. But what I would say is that seeing an increase in EMEA, which we did have here as far as where we're seeing some real benefit in terms of regions where they're shipping. Q4 of 2023, EMEA,

so this is Europe, Middle East, and Africa, that was 8% of system sales, net system sales in Q4 of 2023. In Q1 of 2024, that was up to 20%. Essentially, there was a shift here from, I would say, maybe some other parts of the world into China and Europe. That's kind of interesting here. Now, you are going to see that from time to time here, Dylan. It's just a function of what happens to be the need at the moment. But I'm not surprised to see that China is making bigger investments overall into chip design, chip manufacturing. This is something that they really wanted to step up, domestic chip manufacturing, inside of China proper. So, I can't say that's much of a surprise here. The surprise, if anything, is to see more of this

in Europe, Middle East, and Africa. And maybe I shouldn't be surprised by that, because there are big chip-making facilities on and around the European continent. But it's just a little bit of shifting here. We see this from time to time. But I think, to answer your question about the China trend, we know they want more domestic chip design and production that's right there on the Chinese mainland. So, you're going to need chip-making equipment to do that, to fill out the foundries there inside the Chinese mainland. Can't say I'm too surprised by that. All right, Tim, let's go over to the friendly skies. We got an update from United Airlines this week as well. The company reported

total operating revenue of $12.5 billion, up almost 10% compared to last year. Net loss of just over $100 million. Shares up 10% on this report. High level, this looked like a very impressive report for the airline. I agree. I think there are some very good trends at the unit level here. If we're looking at your passenger revenue per available seat mile, it's up 1%. Given that we're talking about available seat miles, again, we're talking about in the order of $71.7 billion. Actually, are we talking maybe even trillion miles? I'm not even sure if I have this right. But it's a huge number here. When it's up 1% like that, $0.1579 per available seat mile up from $0.1563, that makes a meaningful difference here.

This is a company that's getting more efficient. Their cost per available seat mile is going down 0.6%. You can see that United is delivering more passengers to more places. It does look like travel is really kicking up, which is great to see. This is not being driven by cargo. This is being driven by passengers getting on planes and going around the globe, which is, honestly, given where we were just a few years ago, Dylan, that is really encouraging to see. Yeah. Actually, Tim, last week, we looked at Delta's results, and we got a quick glimpse at what was going on with travel, and we saw international travel returning quite a bit there. We zoom in here on United's, and Asia and Pacific really coming back as well, restoring a

lot of the travel and the routes back to pre-pandemic levels. It seems like international segments for a lot of these airlines are performing incredibly well. Are there any other trends that you're noticing as you're able to kind of stack some of these airline results together? Well, the domestic travel for United has, I mean, just look at domestic load factor here. So, just zeroing in on that. So, on a year-over-year basis, the domestic load factor, so again, this is a function of a completely full plane is 100% load factor. So, anything less than 100% is less than a full plane. The higher the load, the more money that a particular trip would make for the airline. On domestic routes for United in the first quarter, they had a domestic

load factor of 83.7%. That is up from 80.9%. That's 2.8 percentage points year-over-year increase. Fantastic. That is really saying something. They are getting more passengers delivered across the continental United States, that's a very good sign for United because they do so much business here domestically. They're one of the most active carriers in the U.S. proper. So, that is a really good sign. I also think it's really interesting that they are making adjustments for what they have to contend with as the domestic carrier that probably has the most visible, and really, I would say, on a gross basis, the most business with Boeing and the amount of work they're doing to just account for the fact that they're not going to be able to get

as many planes delivered into their fleet from Boeing as they had originally counted on just because of the problems that Boeing has had with manufacturing and the regulatory scrutiny that Boeing is dealing with. And they have said, not only are they making a new lease with Airbus, I thought this was really interesting here. They have agreed to letters of intent with two independent lessors to get 35 new Airbus A321neo aircraft. So, you could think of that as a comparable to Boeing's 737 MAX aircraft, pretty similar aircraft. So, they're just bringing in Airbus aircraft to account for aircraft they're not going to get from Boeing. And they have said, I thought this was a really interesting quote here, Dylan, what we heard

from United in terms of what United Airlines CEO Scott Kirby said, we've adjusted our fleet plan to better reflect the reality of what manufacturers are able to deliver. So, they're going to, they say, profitably grow our mid-continent hubs. So, get ready, Denver and Chicago, for fewer Boeing planes, more Airbus planes, and maybe some Embraer planes? Dylan, I don't know. I'm going to play with a very famous Jeff Bezos quote here and say, for the airline industry, Boeing, your mess up is our opportunity. Yes, I think that's exactly right. The fact that United is already pivoting here at a position of strength, I think, says very good things about the way the carrier is run.

That feels like a good sign here, but of course, remains to be seen. We'll have to see how this actually shakes out in terms of the way they figure out what the fleet mix is here. Kudos to United for planning ahead here, or at least rolling with the punches, knowing that they get so much of their fleet from Boeing, and now they're pivoting a little bit here. Smart move! The airlines and the banks tend to get the earnings party started. But, Tim, you are a man of technology, and in particular, software. I know we're not seeing a lot of the software report quite yet. But as we start to see some of those results come in, what are you going to be looking for this quarter? I'll be looking for how the enterprise

software providers are winning business or not with their largest customers. Are we seeing expansion of dollar-based retention rates amongst their most lucrative customers? Do large customers continue to expand business with these enterprise software companies. That'll be interesting to see. I would also be really interested to see just what the forecasts are for growth rates going in. What does the guidance look like? Is it moderated? Are they offering a much more conservative forecast because of the threat of things like AI, I'm actually expecting that it'll be much more business as usual than it will be, look out, here comes AI. I'm not really buying AI as a short-term disruptor. As a long-term

disruptor, definitely. I think we're going to see a lot more AI substitutions maybe two to five years out. But in the short term, Dylan, I think the best of the enterprise software companies should be able to generate more business from their most lucrative customers. And the ones that are not doing that are going to get a little bit of squint eye from me, and maybe I need to reevaluate the thesis. We'll have you back on to check on those results as they come in. Tim buyers. Thanks for joining me today. Thanks, Dylan. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a

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That's R-I-P-P-L-I-N-G dot A-I slash F-O-O-L. Sign up for exclusive access today, rippling.ai slash fool. Coming up on the show, who's actually buying office buildings right now? And what's going on behind the scenes? My colleague Deidre Woolard caught up with Stephen Jacobs, the president of 10X, an online commercial real estate exchange owned by CoStar, to get an up-close view of a disrupted market. What kinds of properties are you seeing? Are people trying to get to sell a lot of

office right now? And are you taking office? Are you seeing retail? What are you seeing? We're seeing everything. We're seeing all asset classes across the board. We are taking on office and we are actually somewhat, we're being successful with office, but it all comes down to pricing, right? So, it comes down to the owner really understanding, I have a vacant office building wherever, right, whatever market they're in, and it's not a great, you know, adoptive reuse, and they have to get to the right pricing. And for the right pricing, there's an investor out there that says, hey, if I could buy this vacant office building for $0.40 on the dollar or $0.50 on the dollar, I can take on the asset. I now have a much lower basis. I can invest in capital

and I can invest and I can attract a tenant. That is really the play. The other play is, if I can buy this office cheap enough, I'll knock the building down and build something else. There is a lot of talk. I'm sure you're aware of a lot of office, a lot of talk about how you can convert or the goal of converting office to resi. It's a lot harder than it sounds. And there's a lot of office building types, structure, the way they're built, that just don't convert. A lot of big buildings, that's high-rises in major cities, and small, two- or three-story suburban office buildings, they just don't convert. In fact, a client of mine looked at 2,200 office deals that they have in their portfolio, and they came up with only 10% were convertible.

only 10% had the chance to actually, there's the physical aspect of converting, there's the cost, of course, right? But then there's also the approval process in the local cities and towns, which is not easy. So, it's not as easy, but we are taking on everything across the board. And again, if assets are priced right, we're trading them. And if we have a broker that actually really puts out a realistic value for their seller, and everybody's aligned from day one, there's a much higher chance for the asset to trade. Well, and one of the things that we're all sort of watching with the market is if there's going to be a large amount of distress or defaults or anything like that. We haven't quite seen it yet. A lot of people are saying, well, just wait,

it's coming. But I think there's a difference between a stress property when someone would like to make a deal and a distressed property when a deal has to be made. So what are you seeing? Are you seeing any distress? Are you seeing more of the stress side of things or where there's some urgency to get things sold, but it doesn't have to be sold? So we're seeing both, but I want to make a comment on the stress. That's a term that I use. I call it a stress seller, which is not a distressed asset. The real definition of distressed is once an owner defaults on their loan and it moves into special servicing. So, all commercial loans have a servicer, which makes sure that the taxes are paid and the insurance and all that stuff. If you have a

CMBS loan and it defaults, it moves into a special servicer. And in the world of commercial real estate, when you hear special servicer, that's where all the distressed assets sit. But distressed assets can sit, it doesn't have to be a special servicer, it could be at a lender, it could be a local bank that takes the asset back, right? So, the point really is that there's, I just was reviewing this this morning, there's $1.6 trillion of debt that's coming due, $900 billion in 24, and another $600 billion in 25 of commercial debt that is coming due. And what's happening today, point of time is you have a lot of owners that have a maturity date coming up. And because the value of their real estate has gone down and they can't refinance at the same levels,

the equity has been wiped out. So they're facing, can I go get a loan, even at the same loan balance and pay my first loan off and then get my new loan? In some cases, they can do that. But unfortunately, a lot of that debt that's expiring and maturing was written at 70%, 75%, 80% loan to value. And the lenders are only giving out about 50% to 55% right now. So, in most cases of the maturing loans, there's a very good chance that the borrower or owner has to go in their pocket and write a check. And a lot of them don't want to do that. And then they can't even get the financing commitment. So those are stressed sellers. And we have seen a decent amount of that inventory come to us where the seller is just hoping to get the assets sold for their

loan balance. So that is definitely ticking up. Your question about everybody asking about distressed, that's been a little bit slower. We always have distressed assets. We always say we have a lot of distressed seller clients. So, we always have some. But we haven't seen, to your point, a big uptick yet because a lot of what I just explained on the stressed is moving through the system. So, I'm a borrower. I've lost all my equity. My loan is maturing in August. I can't get the financing. I'm going and talking to my lender saying, will you give me an extension? And they say no. Then they're giving the keys back. And that's what starts the distressed inventory, right? So going back to the question on office, there's a lot of office assets that

will not be, they're not going to be able to be redeveloped into anything. So at some point, the owners and borrowers say, here are the keys. And those conversations are happening every day, right? And then what happens is it takes about six to nine months once the keys go back for the asset to run through the traps, like from that initial conversation, which is, I'm not going to be able to refinance you. We're not going to give you an extension, right? Here are the keys. Depending on what state you're in, it could take six to nine months. So, we do expect that the distressed inventory will grow. It is growing. If you look at trap data, it does show the distress is growing. Every month that goes by, it's getting increasing more and more, especially

office. But as far as inventory that we're selling, we expect to see more of it towards the end of the year. Wow. Okay. So you just set up a scenario that's a little bit, it's frightening. And a lot of that too, a lot of those loans are sitting with smaller regional banks, which is another thing that I've been watching and worrying about. Another thing I've been hearing about that maybe you can help explain is commercial real estate collateral loan obligations, CLOs. I've seen a couple of stories lately about those also having an issue. So what impact does that have? What are those? It's very similar to what I just explained, right? And what happens in the CLOs, it really depends how you define the collateralized obligation, but it can go from anywhere where

the borrower has to deposit more money in the lockboxes to be able to cover vacancies or cover TI improvements, right? Because the loan-to-value has shrunk. So, if you maintain a certain loan-to- value, your lender is not going to bother you, right? But if you've lost a tenant and your cash flow is down, then your value goes down. But just purely on math, even if you have your tenants, purely on math, cap rates on a deal that used to be 3% are now 6% and 7%. So, that makes the value go down, which means your loan-to-value gets compromised, which then means you're obligated by your loan obligations to deposit money into these lockboxes to give the lenders more security. And there's borrowers that just are doing it, and there's

borrowers that aren't doing it. And I hosted a, about six or eight weeks ago, I hosted a conference where we have our clients, which are lenders, special servicers, you know, across the board, right? Investors. And they were sharing some of what's going on in their businesses about CLOs, where they are pushing to get deposits into lockboxes and correct some of these loan to values and they're getting some and they're struggling with a bunch. And it just comes down to the simple math of I've owned the building for four years. I put in a couple of million dollars when I bought it. It's now worth X minus Y, which wiped out all my equity.

So why am I going to keep putting money into this asset? Even if I have loan documents that require it. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.