Small Cap Opportunities In TechRoyce Funds
Portfolio manager Bill Hench on the current state of tech and how his outlook on semiconductors differs from the Wall Street consensus.
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What’s your view on the tech sector?
So the tech sector in small-caps, micro-caps, is much, much cheaper than it was. To a larger extent, things have changed and the customer base of technology, specifically devices, semiconductors, even contract manufacturing to some degree, all these things have much, much broader customer bases than they used to. So while a slowdown in mobile phones is worrying, it doesn't necessarily mean that you're going to have supply issues or inventory issues or pricing issues running across the whole spectrum.
“So to value buyers like us, these are opportunities to look at for the next year, two years. These are companies that have gone through a tremendous earning cycle, so they've got lots of cash, not much in the way of debt… So if you can't tell, we like this sector. —Bill Hench
And that's where we think the great opportunity is, right? You've seen many of these names, whether it's on the manufacturing side, the semiconductor manufacturing side, or the device side itself, come down to end of cycle valuations. Six, seven, eight, nine, 10 multiples on things that normally would be trading in the mid-teens at this part of the cycle are now available.
So to value buyers like us, these are opportunities to look at for the next year, two years. These are companies that have gone through a tremendous earning cycle, so they've got lots of cash, not much in the way of debt. Pretty much a runway for a U.S. economy, at least, that looks pretty good. So if you can't tell, we like this sector.
How does your view on semiconductors diverge from the Wall Street consensus?
I think we all agree that it's much less a boom and bust business than it was, you know, two or three cycles ago. And that again is because of the diverse customer base, and the fact that, you know, you have chips everywhere now. We make money at this by understanding that the new world is much more efficient. There are no big inventory situations like there used to be in the past, right? Everybody knows where everything is immediately. So better inventory controls have led to better pricing, and better diversification by customers has led to better pricing. As you look at these things, you see better and better margins, both at up times and down times. And that's the opportunity here—that we’re not really discounting the new world as it is.
What other tech areas look interesting to you?
Well, it's everything. It's every device that is ruled by—or where earnings are ruled by—unit volume. It's connectors, which you can't get enough of, capacitors you can't get enough of. Even contract manufacturing is tightening up a little bit. We’d love to have more software, but software seems to be something that everybody else loves, so pricing is kind of difficult there for us. But there are lots of software opportunities in things like healthcare, aviation, and manufacturing, things like that that give us a pretty good opportunity for representation in the portfolio.
Article By Bill Hench, The Royce Funds