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My six-year-old son Joey is fascinated by Titanic right now.
Over the last five or six months, we've watched NatGeo documentaries and the James Cameron flick on DVDs, have ordered and pored through countless books on the tragic and famous ship, and have even built models of the "Ship of Dreams" from paper, wood, Lego blocks and even a plastic kit.
I love being a Dad. And if you're a parent like I am, I'm betting you understand that this kind of enthusiasm and wonder from a kindergartner is impossible to resist (especially for a guy like me who's a history buff anyway). So during my hour-long commute each morning and night, I've been listening to "Titanic's Last Secrets," the story of uber-cool wreck divers John Chatterton and Richie Kohler.
I'm sharing this personal anecdote because the book's historical backstory reminded me of an important investing lesson – one that we're going to share with you today and show you how to profit from.
Let's start with the lesson.
In the "Last Secrets" book, author Brad Matsen provides a rich-and-detailed backstory that brings the era of ocean travel to life in a very real way. At one point, in giving readers the background of Titanic builder Harland & Wolff, Matsen talks about one of the boom-and-bust peculiarities of the shipping industry – that shipping lines always tended to add to capacity by ordering new ships at the peak (near the end) of a shipping boom.
You continue to see that even today – in the global cargo-shipping industry. During lean periods, shippers "make do" with what they have – older ships that are perhaps too few in number for a surge in demand. Those lean stretches often cause shippers to bleed, to run up big losses, and even to fail.
Eventually, lean periods end – and sometimes a full-fledged "boom" ensues. It takes several years for this to play out, and by the time the years of losses have been covered and profits are peaking, the boom is usually coming to an end.
But that's the time that shippers choose to start placing orders for new ships – en masse. This leads to an overcapacity situation, forces price wars, and actually hastens the arrival of the next shipping-sector downturn.
This ill-advised "boom-and-bust" investing pattern isn't limited to shipping. We see it with housing, new cars, and (at the end of the "dot-bomb" bubble) even fiber-optic networks. (In the late '90s and early 2000s, the expectations for the Internet were so grandiose that dozens of companies built high-speed fiber-optic networks – and created a ruinous glut. In fact, according to one study I remember, when the dot-com bubble imploded, a full 98% of those fiber-optic networks were "dark" – techno-speak for not being used.)
Eventually, this "overhang" in supply gets taken up, paving the way for the next boom.
If you can identify the end of the downturn – and make the "right" investments ahead of the new surge in spending, the profits can be quite remarkable.
And we've reached that point in a key part of the semiconductor sector.
Let me show you just what I mean.
In one of the very first Private Briefing reports of the New Year, we told you that the semiconductor sector was headed for a hot run and that chip stocks would be a major moneymaker here in 2013.
That's just how it's played out.
Now we want to tell you about a new – but related – profit opportunity which could be nearly as lucrative.
We're talking about the semiconductor-equipment sector.
Semiconductors are a foundational element of the global high-tech economy. They're obviously the "brains" of PCs, smartphones and your iPad. But they're even a key component of cars and trucks these days: In fact, demand for microchips in the global auto industry is projected to grow from $22.5 billion in 2010 to $46.9 billion in 2015 – meaning it will double in just five years.
Semiconductors are churned out by "fabs." And a lot of the leading chip companies – smartphone-chip-giant Qualcomm Inc. (Nasdaq: QCOM), for instance – don't even have their own production facilities (meaning they are "fabless" chip firms in chip-industry lexicon).
Fabless firms "farm out" production to third-party specialists – "foundries" – like Tower Semiconductor Ltd. (NASDAQ:TSEM) or Taiwan Semiconductor Manufacturing Company Ltd. (NYSE ADR: TSM). Taiwan Semi is the world's largest independent foundry.
Semiconductor fabs are stunningly expensive to build. Current estimates put the cheapest at about $1 billion – but note that outlays of $3 billion to $4 billion are well within reason. Indeed, a Taiwan Semi fab that was set to open last year was said to carry a price tag of nearly $10 billion.
Those high sticker prices are understandable when you consider just how sophisticated the chip-production process has become. There's a central "clean room" that keeps all dust and particulates out of the microchips. And each fab contains several hundred pieces of equipment – with price tags ranging from just under $1 million to as much as $50 million.
And with semiconductor sales growing so strongly right now, a huge capital-equipment boom is projected for this year and next.
Fab-equipment spending will soar between 23% and 27% next year to as much as $41 billion, after a more-tepid 2% increase this year, according to a new projection by the SEMI World Fab Forecast.
That forecast makes sense when you consider that spending on fab construction will spike about 6.5% this year before tumbling 18% next year.
(Fab construction spending is a good "leading indicator" for equipment spending; chipmakers first have to construct the fab building before they can outfit it with capital equipment.)
The equipment outlays will begin ramping up later this year, with a 32% growth rate over the first six months. The second-half outlay will reach $18.5 billion. The $41 billion in equipment spending projected for next year would be the highest ever, Semi World Fab Forecast reported.
This acceleration in spending is attributed to growing semiconductor demand and an improving average selling price for chips – which we told you about back in early May.
Now that we have these insights, the next step is to show you ways to profit.
And we have several.
The first, which we'll share today, is Kulicke and Soffa Industries Inc. (Nasdaq: KLIC), a chip-equipment maker we first recommended back in March 2012. The stock actually rose as much as 15% soon after we told you about it, but has whipsawed investors ever since.
But now we believe the Fort Washington, Pa.-based Kulicke is positioned to benefit from this big surge in semi-sector capital spending.
The company designs, manufactures and sells capital equipment and expendable tools used to assemble semiconductor devices, including integrated circuits (IC), high- and low-powered discrete devices, light-emitting diodes (LEDs), and power modules. It also services and upgrades any of its gear that's out in the field.
When Permanent Wealth Investor Editor Martin Hutchinson first recommended this stock to you, one big reason was its "margin of safety:" The company had ended 2011 with $378 million in cash, up from $178 million at the end of 2010.
Well, that margin of safety is even better now: At the end of the first quarter, Kulicke had $498.6 million in cash on its balance sheet. With 75.22 million shares outstanding, you're talking roughly $6.63 per share in cash – or about 61% of yesterday's afternoon share price of $10.89.
The company is projected to grow sales at 19.5% and earnings at 13.5%, and earn $1.45 next year. That means the stock is trading at about 7.5 times forward earnings, giving it a "PEG ratio" of 0.56. That's cheap.
Hedge fund managers are stepping up their purchases of Kulicke shares: There was a 10% increase in ownership from the end of the first quarter to the end of the second.
"Bill, in my view K&S is very underpriced indeed," Martin said yesterday. "And that points to a significant potential upside."
The consensus target price on the stock is $15.67 – though estimates go as high as $18. That would represent gains of 46% to 65% from current levels.
And this isn't the only semi-equipment play we have for you: I recently had a long chat with resident tech expert Michael Robinson, who identified several more companies that could capitalize on this capital-spending boom. We're studying them carefully and hope to have them for you in a few days.
So stay tuned …
[Editor's Note: Unless we specify otherwise, we recommend that investors employ a 25% "trailing stop" on all investments.]