Siltronic AG: Well Positioned For The Next Cycle

Siltronic AG (OTCPK:SSLLF) has had a challenging first quarter. And to make matters worse, the outlook for the remainder of 2023 is rather bleak, too. But while the immediate future mainly holds challenges for the German producer of silicon wafers given the highly cyclical nature of the business, I believe that the negative factors are priced into the current share price. I have little doubt that the market will turn around with a vengeance in the medium to long term, and I believe Siltronic is well positioned to take advantage going forward. Below, I will explain, why I believe that Siltronic is a company to keep an eye on as a potential buy.

Long Term Growth

Despite considerable headwinds, the semiconductor industry stands to profit from global megatrends in the long term. Artificial intelligence, electrified (and potentially autonomous) vehicles, various kinds of smart devices – they all require chips in order to function.

Hence, increased demand appears overwhelmingly likely in the medium to long term. And the market seems to understand that, at least in principle. Look no further than Nvidia Corp.’s (NVDA) recent rally. If the makers of chips see growth, so do the producers of wafers, eventually. The causality is virtually inevitable. There can be no semiconductors without wafers.

Financially Healthy, Even In A Downturn

But to return to the present for the moment: currently, the semiconductor market and with its suppliers such as silicon wafer producers are in a down cycle. And Siltronic is feeling the heat. Nonetheless, given the circumstances, I believe the company is weathering the storm relatively well.

While certainly hit hard in Q1, Siltronic remains profitable, with a quarterly EBIT of €72.5 million (EBITDA: €125.2 million). The earnings per share amount to a respectable €2.2, even in a rather adverse environment. Despite several quarters of negative net cash flows due to high capex (and dividend payments amounting to around €90 million in 2022), the company still reported net financial assets of €284 million as of March 31^st. Compared to the prior quarter (revenue: €472.1 million; EBITDA: €168.1 million; EBIT: €124.8 million), the numbers appear abysmal, no doubt. Then again, 2022 was a record year with an EBIT of €496 million and EBITDA of €672 million.

Cash Flow Improvements Imminent

As is, much of the bad news from the macro-side appears to be priced in. And the company’s cashflows are likely to improve significantly going forward. The aforementioned capex is forecast to rise to a level slightly higher than in FY2022 (slightly above €1 billion). Yet, this will be the peak for the foreseeable future. With the Singapore fab on schedule to be completed next year, capex will meaningfully reduce from 2024 onwards. The company forecasts a reduction by about 50 percent.

That will meaningfully improve cash flows, especially once the new fab begins to churn out state-of-the-art wafers. Add to that, a likely recovery of demand and profitability at or above the 2022 levels (EPS: €13.03) could be a reality towards the second half of the decade.

The competition

The wafer market is an oligopoly dominated by just five companies. The main competitors are Shin-Etsu Chemical Co. Ltd. (OTCPK:SHECF;OTCPK:SHECY), Sumco Corp. (OTCPK:SUMCF;OTCPK:SUOPY), both from Japan, Taiwanese GlobalWafers Co. Ltd. (6488.TWO) and Korean SK Inc.’s (034730.KS) subsidiary SK Siltron. Siltronic is the only major non-Asian domiciled manufacturer of silicon wafers. However, it should be noted that the company has significant (and increasing) exposure to Asia in terms of both production and sales. Silicon wafers are high-tech products which require a high degree of know-how to produce. Hence, there is a relatively high barrier to entry, even for players with deep pockets (such as, for instance, Chinese state owned enterprises). So, for the foreseeable future, the aforementioned four companies are the yardstick to measure Siltronic against. SK Siltron is a part of a Chaebol conglomerate and is not separately listed. Shin-Etsu, meanwhile, is much more diversified than Siltronic. That leaves GlobalWafers and Sumco as the best direct comparisons.

Siltronic’s relative market share of around 15 percent has been more or less stable for the last decade. The company does by no means outperform its peers. On the contrary: Siltronic’s revenues and profits have been hit harder than its listed competitors’ recently. Compared to the fourth quarter, the company reported – 14.3 percent sales (Sumco: -6.3 percent; GlobalWafers: +1.2 percent), - 25.5 percent EBITDA (Sumco: -6.3 percent) and even -37.66 percent EBIT (Sumco: -13.7 percent; GlobalWafers -4 percent). Factoring in a €5.7 million write-up in Q4 due to the reversal of prior impairments on real estate, Siltronic’s EBIT only decreased by - 34.67 percent. Still, the decline is much more pronounced on a relative basis.

The above numbers are, however, in the respective local currencies. It should be noted that the Euro performed significantly stronger relative to the Dollar than the Yen and NTD did. This puts the percentage figures in perspective, at least somewhat.

During the up-cycle, growth metrics were comparable with competitors. The wafer market can be described in a proverb: A rising tide lifts all boats (and vice versa). Admittedly, it could be one downside that Siltronic only produces 200mm wafers (but not 300mm wafers) in the US. GlobalWafers, on the other hand, has recently begun construction of a 300mm wafer plant in Sherman, Texas. Going forward, I would not entirely rule out that US production could be a competitive advantage, subject to certain “buy American” standards and incentives for US customers. Nonetheless, I am confident that there will be ample buyers for the new Singapore fab’s output.

Do Not Expect A Buyout Anytime Soon

While there may be some fantasy of Siltronic, being one of the smaller players in its field, becoming a strategic takeover target, I do not see such consolidation unfolding in the near to medium term. The fact that the current German federal government blocked an acquisition by GlobalWafers (which offered €147 per share for Siltronic) makes this scenario rather unlikely for the time being (the next federal election will be in late 2025). After all, the would-be buyer was not a Chinese or Russian company. If an offer from Taiwan is blocked, one has to assume, that a similar approach would be taken with regard to a Korean or Japanese competitor. Of course, a future transaction can never be ruled out entirely, but for the time being, it seems rather unlikely from my point of view. Even more so, as given the current political sentiment, the Green party of Robert Habeck, the minister who was the driving force behind blocking the GlobalWafers proposal, appears not unlikely to be a part of the next government coalition, regardless of which party will lead it.

Valuation

Siltronic is historically cheap. Currently, the stock trades at around 11 times forward earnings based on down-cycle earnings (I am assuming full year EPS of around €7, which leaves a certain margin of safety). Sumco, on the other hand, trades at around 15 times its forecast 2023 earnings. And GlobalWafers even trades at slightly above 12 times TTM earnings – remember: 2022 was a record year for the industry.

Given this comparison, I think that a multiple of closer to 15 times forward earnings would not be unreasonable for Siltronic in the medium to long term. That translates to a price in the vicinity of €105 (= around $114 at current exchange rates). From the current price level, this leaves an upside of around 35 percent.

Siltronic is probably not a name, that I am in a particular hurry to buy. Nonetheless, the company surely deserves a spot on my list of potential buys, if a compelling opportunity (read: a dip) arises. Given the extremely cyclical nature of the business, one might have to wait a few quarters for the global economy to get back into growth mode. While waiting, a dividend yield of 3+ percent may be a welcome benefit. As per its dividend policy, the company aims to distribute 40 percent of annual net income, capped at €3 per share. Based on the down cycle performance, I expect the dividend not to drop below €2.5 (translating to a yield of 3.2 percent based on the current share price).

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