Description

I recommend purchasing shares of Ichor, a $1.2bn market cap, semi-cap subsystem provider. The semi-cap cycle is bottoming, and while semi-cap stocks have been big winners over the last 18 months, the subsystem names have not followed suit. This is a divergence from the past which I believe will correct itself as the outlook for these companies begins to improve. While the group (mainly MKSI, UCTT, and ICHR) will likely move together, I find ICHR particularly compelling as it has positioned itself to achieve improved profit margins this cycle compared to previous ones. I believe shares offer at least 60% upside from here and the potential to more than double through the cycle.

Company Overview. ICHR is a leading provider of WFE subsystems and components. The majority of its revenue (80%+) comes from its top 3 customers - AMAT (36%), LRCX (35%), ASML (11%). Its main products are gas and chemicals delivery systems and subsystems that deliver, monitor, and control precise quantities of critical gases/chemicals used in the semiconductor manufacturing process. The company also provides precision-machined components, weldments, precision vacuum and surface treatment technologies, and other proprietary products.

Several key semiconductor technology inflections such as gate-all-around, 3D-DRAM, and HBM/advanced packaging are driving strong demand for WFE and WFE with significant fluid delivery requirements in particular.

As WFE has required more fluid delivery content per tool, ICHR has, in turn, taken a larger share as a percentage of WFE spend.

Subsystem Divergence from semi-cap. The chart below shows how the US semi-cap and semi-cap subsystem companies have historically traded together. However, since late 2022 this relationship has disconnected. I expect this gap to close when semiconductor capex begins to take off in 2025.

The cycle is bottoming. Consensus has ICHR’s big 3 customers’ revenue declining in aggregate by ~3% in 2024 followed by 21% growth in 2025 and 11% in 2026. The chart below shows ICHR’s revenue as a percentage of their revenue over the last decade. This represents a bull whip effect where subsystems suppliers outgrow their customers in the upcycle and suffer more in the down cycle as customers work through inventories of ICHR's products.

ICHR’s inventory days peaked in 4Q23 and declined in 1Q24. In past cycles this has typically marked a point where sales growth returns, followed by margin expansion 4-5 quarters later. Once this bottoms, I expect ICHR’s revenue as a percentage of its big 3 customers’ revenue to once again surpass 2%.

Proprietary components should lead to higher margins this cycle. Currently ICHR’s gas panel bill of materials contains 10% internally supplied components. The company believes it can increase this to 80%. While components that represent 30% of the bill of materials such as seals, weldments, and fittings have been qualified by customers, flow controllers and valves are currently in the process of getting qualified. Combined these represent another 50% of the bill of the materials. Once these are qualified, ICHR’s new products this cycle could carry a 25% incremental gross margin vs ~19% last cycle.

Financials/ Valuation

I believe ICHR can capture ~1.6% of the big 3 customer sales by 2026, which would shake out to ~$1.5bn in revenue for what I estimate to represent mid-cycle. At that revenue level the company believes it can achieve the margins in its target model below, which would imply mid-cycle earnings of ~$6.00.

While I can’t see ICHR’s financials prior to 2014, last cycle saw peak to peak revenue growth of 55%. While its closest peer UCTT, saw revenues double peak-to-peak in previous cycles. While there is some M&A in there, let’s keep things simple and assume ICHR can grow peak-to-peak revenues by 55% again this cycle. In that case it will do nearly $2bn in revenue at the top, which should translate into ~$8.80 in peak-cycle EPS based on the incremental margins described above. If peak-to-peak revenues double like UCTT, then it could generate ~$11.30 in peak-EPS.

Frankly, I’m not sure what the right multiple to put on mid-cycles earnings is but ICHR shares are trading on 6.3x what I believe to be mid-cycle earnings, which simply seems way too cheap. The S&P for comparison is on 17.5x 2026 earnings estimates and at that multiple you would get a price of $105 (175% upside).

During previous cycles, ICHR traded on 7x peak earnings. If we apply this to the peak-EPS scenarios above, we get a share price of $61.60 to $79.10 (62-108% upside).

Catalyst

Recovery in WFE spending.