Entegris Offers An Exceptional Growth Story, And A Rich Valuation

 

It’s been a while since I’ve written on Entegris (ENTG), but this is a semiconductor supplier where I’ve loved the story for a long time. And why not? Entegris focuses on specialty materials and systems for the semiconductor industry and is directly leveraged not only to volume growth, but increasing complexity in chip design. With good moats, strong underlying chip volume growth, healthy margins, and opportunities to apply its core capabilities into other growth markets (like bioproduction), there’s a lot to like.

The exception is valuation. That combination of strong underlying growth, margin leverage, and defensible market positions has led to a robust valuation that I find very difficult to reconcile to the fundamentals. Of course there will be growth/momentum investors to tell you how valuation doesn’t matter, and maybe this is a case where it’s true, but at this point Entegris is basically a leveraged bet on even more semiconductor industry volume and company-specific content growth, as well as opportunities in life sciences.

 

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Entegris Offers An Exceptional Growth Story, And A Rich Valuation

Merck KGaA Crashes Into The Versum-Entegris Tie-Up

I liked both Versum (VSM) and Entegris (ENTG) in the fall of 2018, Entegris a little moreso, on the idea that the market was overreacting to the correction cycle in semiconductors and semiconductor equipment and that underlying chip production (a key driver for Versum) was unlikely to be impacted as much as seemed to be reflected in the prices. When Versum and Entegris announced their intent to merge in late January, I thought it made a lot of sense and would create a stronger new company, led by management team (Entegris) with a lot of experience in M&A integration.

Now Merck KGaA (OTCPK:MKKGY) has pushed itself into the conversation, making an unsolicited all-cash offer that is well above the upfront value offered by the Entegris deal. Although I can see why some shareholders may prefer a stock-for-stock bid and I believe there are some regulatory risks to the Merck KGaA offer, it’s hard to argue with an all-cash offer that is well above what Versum shareholders were otherwise expecting.

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Merck KGaA Crashes Into The Versum-Entegris Tie-Up

Versum Leveraged To Chip Volume Growth And Innovation

On the whole, I like pick-and-shovel plays and Versum Materials (VSM) is a good example in the chip space, as this producer of specialty chemicals, gases, and other materials is heavily leveraged to ongoing growth in chip production volume and ever-increasing chip design complexity. Although Versum has some modest exposure to equipment and some volume risk from improving yields, the general outlook for Versum is healthy as a critical supplier to fabs.

Relative to Entegris (ENTG), though, I’m not quite as interested in the value proposition offered by these shares. I do think Versum is modestly undervalued, and it’s more of a play on direct chemical/material demand, but expectations might still be a little high for 2019 and I still see ongoing risk of the market being indiscriminate in selling off semiconductor-related names if (“when”, in my view) the outlook for equipment demand in 2019 worsens.

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Versum Leveraged To Chip Volume Growth And Innovation

Entegris Not Getting Its Due For A Differentiated Exposure To Semiconductor Markets

Electrochemical, filtration, and material handling company Entegris (ENTG) has had a rough year, as has competitor/peer Versum Materials (VSM), though investors in semiconductor equipment stocks like AEIS (AEIS) and VAT (OTCPK:VACNY) may not exactly be overflowing with sympathy (they've had it worse). Although Entegris is much more leveraged to wafer starts than equipment orders, investors seem to have bailed out ahead of this memory-led decline in equipment orders.

Although Entegris has some exposure to equipment trends and wafer starts may not be so strong next year, I think these shares are starting to look pretty interesting. Margins should continue to head higher (driving a better EV/revenue multiple), and I see meaningful room for FCF margin expansion as Entegris leverages ongoing growth in chip production and ever-increasing chip complexity. My biggest concern is perceptual, with the risk that investors look at the worsening outlook for equipment and high lead times and just bail on all things chip-related.

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Entegris Not Getting Its Due For A Differentiated Exposure To Semiconductor Markets

Danaher's Pall Investor Meeting Underscores Several Business Strengths

In isolation, Danaher’s (DHR) investor day focusing on the Pall operations doesn’t really change anything about the story. What I believe is more important, though, is what the presentation reveals about the company’s much-lauded Danaher Business System (or DBS) and its ability to drive value from M&A.

With Danaher successfully integrating and improving companies across the range of revenue growth and R&D intensity, I believe Danaher has a compelling case for how and why it can continue to buy companies (particularly in life sciences and diagnostics) at seemingly high valuations and still generate value from the process and capital invested.

Danaher’s life science opportunities are significant, and I see no reason to believe that the company is looking at any significant near-term issues in the water or product ID businesses. Management was actually more optimistic than I expected on conditions in the semiconductor sector, and the company is leveraging its pricing power and supply chain flexibility to minimize the disturbances from tariffs.

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Danaher's Pall Investor Meeting Underscores Several Business Strengths

Seeking Alpha: Entegris Is Another Small-Cap Play On Future Semi Spending

Investors aren't exactly in danger of running out of ways to play expected improvements in semiconductor capital spending in 2014. I've already talked about opportunities in companies like Ultratech (UTEK) and Mattson (MTSN), and both appear to offer significant value if and when next-gen capital spending increases.

Entegris (ENTG) is a different sort of play. Unlike Ultratech and Mattson, there really isn't much of a missionary aspect to sales - semiconductor manufacturers already understand the need for contamination control and advanced material handling, and Entegris already holds solid share in its core markets. That said, more advanced fab processes should require more filtration equipment and a larger sales opportunity for Entegris. While I don't necessarily see as much upside in the Entegris bull-case scenario (compared to Ultratech or Mattson, that is), I believe there is less execution risk here and still an opportunity to generate worthwhile capital gains.

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Entegris Is Another Small-Cap Play On Future Semi Spending

Investopedia: Pall Always Gets The Benefit Of The Doubt

I'd hate to be short Pall (NYSE:PLL), as large companies in the filtration space often seem as close to bulletproof as you can find in the market. So even though sell-side analysts chronically overestimate Pall's free cash flow, investors remain happy with a company that admittedly enjoys strong share and a very lucrative channel of repeat business. While I think Pall's shares remain overvalued, I don't have any particular reason to believe that the shares will sell off dramatically, as the life sciences business should be stable and the industrial business should start improving next year.

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http://www.investopedia.com/stock-analysis/082913/pall-always-gets-benefit-doubt-pll-dci-entg-iex.aspx

Big Differences Of Opinion On MEMC

An old rule of thumb says it is difficult to make any real money from names where the analysts are already all in agreement. The idea is that everybody already knows the story, and the only way to profit is to be contrarian (and right!). So, what should investors make of MEMC Electronic Materials (NYSE: WFR)? Analysts are all over the place on this name, and this seems like a classic case where an investor with better information (or a luckier guess) could make some real money.

Third Quarter Results - Better But Not Better Enough
In a vacuum, there would seem to be little wrong with the company's third quarter. Revenue rose 62% from last year and 12% from the Q2, as solar materials were up strongly and semiconductor materials demand was positive as well. Nevertheless, the company was about 6% shy of analyst estimates, and there is ample skepticism about the near-term outlook for demand in both semiconductors and solar energy.

The link below leads to the full piece:
http://stocks.investopedia.com/stock-analysis/2010/Big-Differences-Of-Opinion-On-MEMC-WFR-ENTG-CCMP-ATMI-RNWEY-SUOPY-STP1103.aspx