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The “Tech Shock” Casualties: Companies to Avoid

SPECIAL REPORTA Brownstone Research PublicationThe Tech Shock Casualties: Companies to AvoidBy Jeff Brown2 The Near Future ReportThe Tech Shock Casualties: Companies to Avoid By Jeff Brown, Editor, The Near Future ReportThe world is running dangerously low on its most important commodity. It s not gold, copper, oil, or even water. I m referring to semiconductors, sometimes referred to as computer chips or simply chips. I m sure most investors are familiar with semiconductors. They are the brains of modern electronics. Semiconductors have been the engine that has driven the exponential growth in computing power that we ve enjoyed over the past several decades. Advances in semiconductors are the reason we carry around a supercomputer in our pocket that is millions of times more powerful than the Apollo 11 the importance of semiconductors goes beyond smartphones and laptops and other consumer electronics that we often associate the components with. It s not an exaggeration to say that without semiconductors many of the machines we depend on every day would simply not we program our coffee maker to begin brewing at the precise time we wake up, we have a semiconductor to thank.

next three years to raise capacity. • On April 15, 2021, TSM said it will raise its full-year CapEx from $28 billion to $30–$31 billion. • In September 2021, TSM announced that it would be raising prices on its most advanced semiconductors by 10%, and the price of its less advanced semiconductors will rise by 20%.

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Transcription of The “Tech Shock” Casualties: Companies to Avoid

1 SPECIAL REPORTA Brownstone Research PublicationThe Tech Shock Casualties: Companies to AvoidBy Jeff Brown2 The Near Future ReportThe Tech Shock Casualties: Companies to Avoid By Jeff Brown, Editor, The Near Future ReportThe world is running dangerously low on its most important commodity. It s not gold, copper, oil, or even water. I m referring to semiconductors, sometimes referred to as computer chips or simply chips. I m sure most investors are familiar with semiconductors. They are the brains of modern electronics. Semiconductors have been the engine that has driven the exponential growth in computing power that we ve enjoyed over the past several decades. Advances in semiconductors are the reason we carry around a supercomputer in our pocket that is millions of times more powerful than the Apollo 11 the importance of semiconductors goes beyond smartphones and laptops and other consumer electronics that we often associate the components with. It s not an exaggeration to say that without semiconductors many of the machines we depend on every day would simply not we program our coffee maker to begin brewing at the precise time we wake up, we have a semiconductor to thank.

2 When our air conditioning automatically kicks on to cool our house, it s thanks to a handful of semiconductors. When we wash our clothes, turn on our television, or drive to work; each machine we use to accomplish these tasks requires semiconductors. Modern cars, especially, are dependent on semiconductors for nearly every aspect of the vehicle. Cars wouldn t be safe without them. Approximately 40% of the cost associated with building a new car comes from electronics systems powered by semiconductors. The current semiconductor shortage is the reason why it seems so difficult to purchase a new car today. Automakers simply don t have the necessary components to build their cars. Ford had to shut down its Chicago factory which produces the Ford Explorer and Lincoln Aviator SUVs for over a month. And Ford recently announced it s planning more downtime for five North American factories that produce the popular F-150 pickup the recent shortages are affecting more than just vehicles.

3 Looking to purchase a new home appliance? That s already difficult for many models. Companies like LG have warned that this chip shortage could seep into the television, toaster, and washing machine markets as This Time Is DifferentAs my longtime readers know, I spent much of my career as an executive in the semiconductor Special Report20213 The Near Future Reportindustry. So I can say from personal experience that these boom-and-bust cycles in the industry are not new. This is a normal industry dynamic, as building manufacturing capacity takes time, and the industry always overbuilds, which results in a glut of semiconductors. When that happens, capital expenditures slow down, and the industry waits for demand to catch up with industry capacity. And it starts all over what is uncommon this time is that the rate of technological advancement in technologies like artificial intelligence, machine learning, autonomous driving, and blockchain technology is moving faster than at any time in history.

4 In fact, just ten years ago, these technologies were barely in use. These technologies are creating entirely new markets that didn t exist before. For this reason, the chip shortage won t be fixed overnight, and this cycle is unlike anything I ve ever seen (INTC) and Taiwan Semiconductor (TSM) both said the shortage is likely to extend into 2022. To meet this new demand, TSM (the world s largest semiconductor foundry) is quickly raising its planned capital expenditures. In 2019, TSM was only expected to spend $10 billion to build out new factories in 2020. It ended up spending $17 billion. On March 31, 2021, TSM said it will spend $28 billion in 2021 and $100 billion over the next three years to raise capacity. On April 15, 2021, TSM said it will raise its full-year CapEx from $28 billion to $30 $31 billion. In September 2021, TSM announced that it would be raising prices on its most advanced semiconductors by 10%, and the price of its less advanced semiconductors will rise by 20%.

5 TSM is quickly raising its CapEx in order to build new factors and spend even more on research and development. And it isn t the only one. Intel is beginning to spend $20 billion to start its new foundry business. Samsung said it will spend $28 billion in 2021 to build out new fabrication plants. And portfolio company Micron will spend $9 typical semiconductor foundry takes two to three years to build. These Companies aren t going to spend billions of dollars just to fix a short-term problem. The livelihoods of these Companies depend on forecasting the semiconductor market. And they believe this increased demand for semiconductors is here to stay. And they re this report, I outlined which Companies in our model portfolio will actually benefit from this dynamic. These semiconductor Companies should see record demand in the months and years ahead. But there is also the other side of this coin to consider. Which Companies should we be wary of as the chip shortage plays out?Be Wary of These Six StocksThe types of investments I recommend we Avoid will be stocks that are richly valued and/or could be negatively impacted by the current semiconductor shortage.

6 Below, I ve outlined six Companies I recommend we steer clear of for the time be clear, if a name makes this list, it does not mean that they are a bad company. In fact at the right valuation and with the chip shortage addressed some of these Companies might make attractive investment opportunities. But the current chip shortage will be a headwind for these businesses. And it means we will want to Avoid them until the current shortage is addressed. 4 The Near Future ReportIntuitive Surgical (ISRG)For the past twenty years, Intuitive Surgical has been one of the greatest success stories in high technology. The stock has returned more than 14,000% since its IPO in June I admire the work Intuitive Surgical has done. But I wouldn t want to be an investor in this company right now. Intuitive Surgical offers is a robotics-assisted surgery company. Intuitive s Da Vinci XI is a very large system with four robotic arms used to create four separate incisions in the body to perform a surgery.

7 This is the core of Intuitive s business s Da Vinci Xi Source: Intuitive SurgicalTo provide a sense of scale, if three six-foot tall adults stood shoulder to shoulder in front of a Da Vinci Xi, the robot would be slightly taller and about the equivalent in problem with Intuitive right now is that the company is not a high-volume producer. And while these robots save countless lives by providing a more sterile surgical environment, Intuitive is unlikely to be a priority for semiconductor manufacturers. The company only ships about 100 robotic units a That s compared to Apple, which ships on average, 16 million iPhones a Surgical is likely not a priority for its suppliers. And the company knows that. In its most recent quarterly filing Intuitive added a semiconductor shortage as a potential problem in the Risks and Uncertainties section. Intuitive said, We have experienced, and could continue to experience, increased difficulties in obtaining a sufficient amount of materials in the semiconductor, and other, markets.

8 The timing of this is suspicious. We ve had a semiconductor shortage since early 2020. But Intuitive must have thought they could navigate otherwise they would have mentioned this in the Risks and Uncertainties section sooner. So seeing it now for the first time makes me wonder if they are experiencing new supply chain Intuitive is overvalued right now. As of 5 The Near Future ReportSeptember 2021, it s trading at an inflated valuation of 23 times its EV/Sales. Any disruption to the supply chain will cause ISRG s stock to potentially more than 50%. That will put it more in line with Companies only growing revenue 13% a year at similar gross is a fantastic company, but at its current valuation and the risk of a drop in sales due to the chip shortage, this is a company to (GRMN)Garmin is mainly known for its GPS (global positioning system) products. Its GPS technology goes in many products like cars, fitness trackers, fish finders, golf devices, dog trackers, these electronics are important, especially the navigation tools, they do not require bleeding-edge semiconductors.

9 That leaves Garmin fighting for semiconductors with every other company looking for similar components needed to build their electronics. This is not a good place to be in. Making matters worse, Garmin has projected that its revenues will grow an impressive 18% in 2021; but that assumes no supply problems. That s their fastest growth rate in over a decade. To meet that, Garmin simply can t have any supply disruptions. And in their 2020 year-end earnings call, CEO Clifton Pemble said that, so far, the company had been been able to work through those kinds of constraints with our safety stock. But he went on to say that it s definitely noticeably more challenging in this environment to ensure their supply chains. This feels like he s hedging his bets and warning investors that supply disruptions could happen. But Wall Street hasn t factored this in. The company is trading at its highest EV/Sales ratio in over a decade as talk of supply disruption will send Garmin shares tumbling.

10 Likely down to its average valuation over the past decade 50% lower than it trades as of September (GNRC)Generac is known as a power generation and storage company. Perhaps we ve seen the television commercials for the company s at-home generators. Generac always seems to run those commercials on The Weather Channel during hurricane season. Not a bad marketing strategy. The main story driving the company s recent runup in price is that Generac is transitioning from diesel backup generators to green energy power and storage options. Solar panels require a lot of semiconductors and converters to convert sunlight into electricity and then guide it to where the electricity will be used or stored. This clean energy business line is Generac s main growth engine. It s projected to grow 75 100% in 2021. If anything were to happen to the supply chain here, Generac s main growth engine would be crippled. And so would its core product line of backup like the other Companies on this list, Generac is trading at a decade-high valuation.