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“Chipping Away” at Inflation

Simon believes a vital player in the semiconductor industry could be an opportunity for investors looking for stability.

October 22, 2021

For me, the recent concerns about inflation really just boil down to who has the pricing power.

When the costs of things go up, your company’s costs of goods sold will similarly increase. If you keep your prices the same as they are today and get hit with higher costs, you’ll need to accept a lower profit margin. Or if your company was already unprofitable to begin with, you’ll soon be going even deeper into the red.

As a recourse, companies normally try to pass along rising costs to their customers through price increases. In competitive markets like commodities or retail, this can be difficult. Chances are that they’ll have a competitor with an identical or very similar product, that’s willing to take the loss just to gain a few points of market share.

There are some pockets of the market that are largely immune to inflation. People are still going to need heart surgeries — and most insurers will still reimburse for them — regardless of how much their prices increase. Fields like these are price inelastic; where a massive increase in pricing doesn’t really trigger a massive decrease in the volume of demand.

As investors, we can similarly seek out these quasi-monopolies of the commercial world that are price inelastic and relatively immune to inflationary concerns. We can look for publicly-traded companies with strong pricing power and captive demand from a loyal base of customers.

One sector that I believe will be largely unharmed by inflation is the semiconductor industry.

More chips, please

We’re in the middle of an unprecedented chip shortage. Companies creating products of all shapes and sizes — from appliances to wearable devices to automobiles — are doing whatever they can to get the high-performance chips they need to embed within them.

This is an exciting time for the companies who manufacture those chips. Fabrication facilities are capital intensive and are built upon proprietary intellectual property, meaning it’s not easy for competitors to set up shop and displace them. Taiwan Semiconductor (NYSE: TSM), Intel (NASDAQ: INTC), and Samsung (OTC: SSNLF) enjoy an industry oligopoly here. Each has a significant backlog already in place, and each is spending tens of billions of dollars to add to their capacity as quickly as possible.

Yet there’s one company that is a step upstream of those “Fab Three” manufacturers. And it produces a vital component that’s absolutely necessary to produce the world’s highest performance chips.

One hidden winner

ASML (NASDAQ: ASML) is perhaps the most inflation-immune company on the planet. The Dutch company’s extreme ultraviolet (EUV) lithography machines are required for etching any semiconductors with nodes smaller than seven nanometers. That means if Taiwan Semi, Intel, or Samsung want to produce the most innovative chips, they’re locked in with ASML to do so.

ASML’s EUV machines cost $150 million apiece. They have more than 100,000 parts and take two years to assemble. The company also has a backlog worth 20 billion euros already in place — which are orders they’ve already received and are in the process of fulfilling. At its current production rates, that means two full years of orders are already on the books.

If the costs of any of those 100,000 components go up, no problem. ASML can very easily pass those rising prices along to its customers for any future orders. Their customers have absolutely nowhere else to go for a second supplier.

I’m a firm believer that this spiking demand for chips is here to stay. ASML could be a perfect opportunity for investors looking for stability in a rising tide of inflation.

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