Canon – the next big semiconductor supplier?

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It was hard not to notice over the last few weeks alerts about Canon’s breakthrough announcement. The Japanese conglomerate has been working for a decade on a completely new technology compared to ASML’s EUV monopoly of how to produce small, state of the art semiconductors. Canon has an own approach that will soon enter the market. Could the stock of Canon be in the starting blocks for a new era?

Summary and key takeaways from today’s Weekly
– Canon is a household name, especially due to its leading consumer tech offerings.
– However, they are in secularly declining markets, responsible for 75% of sales.
– Canon is trying to transform itself, having a promising industrial business unit. But too many unknowns remain, so it is more a candidate for the watchlist.

Those who are interested or even invested in the semiconductor sector, likely know that the Dutch company ASML (NL0010273215, Ticker: ASML) is the crucial technology inventor and the most important supplier of machines for the production of state of the art semiconductors like computer chips (CPUs), graphics chips (GPUs), memory (RAM) or flash drives (NAND).

Without ASML, no high-end hardware – or at least a few generations back.

Basically and in very short, these machines use ultraviolet light to burn nanometer-sized structures on silicon wafers which are used as the basis for semiconductors.

A nanometer is a billionth of a meter – your fingernails grow by a nanometer every second and one of your hairs is around 80,000 to 100,000 nanometers thick (see here for more examples). To put this into perspective, Apple (ISIN: US0378331005, Ticker: AAPL) just presented the world’s first 3nm chips they designed in their recent products like the iPhone 15 Pros or the new MacBook Pros.

The smaller the structures, the more transistors fit on the same given unit area, increasing the density and thus also the computational performance, as more calculations can be conducted. Or you can make a chip smaller, while having the same computing power. A transistor is the most important component of an electronic semiconductor and responsible for controlling low electrical voltages and currents.

ASML is dominating this market by a wide margin.

It is even unimportant who creates the best chips, as they all need the best machines to produce them (or let them be produced by specialized third-party companies).

source: Gerd Altmann on Pixabay

The older generation, called DUV (deep ultraviolet light), however, have reached their physical limitations. ASML’s newer and proprietary technology EUV (extreme ultraviolet light) is currently THE industry benchmark. It circumvents DUV’s limitations by using uv light of extremely short wavelength – almost 14x shorter than DUV which allows for higher precision results.

This technology is unique to ASML and pretty expensive with a single machine costing a few hundred millions. Besides the high price tag, these machines consume large amounts of energy. ASML is currently the only company capable of producing these mission-critical machines – a monopoly.

To answer one the most often asked questions directly at the beginning:

NO, Canon (ISIN: JP3242800005, Ticker: 7751) very likely will not compete seriously with ASML on its EUV technology. Even Canon’s management made it clear. As ASML is likely to keep its position for years to come, from here we put ASML aside. It is a highly covered darling of many with not a low valuation and no real potential to surprise to the upside. I prefer to look where others don’t.

And this is where the Japanese conglomerate comes into play. Canon, the current distant number two, has other plans and what it presented so far may even have the potential to revive this old company.

Today, we are going to have a look at Canon as a whole and try to estimate what potential an assumed successful launch of its new machines could bring.

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Spot, light, camera – action!

Founded in 1933, Canon is a 90 year old company.

It is mainly known for its (consumer) electronics products for two good reasons. Canon’s printing and imaging divisions generate together around 75% of total sales.

Many people will know Canon laser or ink jet printers, especially from the office. Before a reorganization in 2020, the printing division had the name “office”. In the majority of the last ten years, the printing / office division contributed around or even more than 50% to total sales, hovering around 2 trillion yen (about 13 bn. USD at current exchange rates).

source: Canon (see here)

However, total sales have fluctuated heavily and are today still more or less where they have been in 2013 as printing as such is on the decline.

source: Canon (see here)

Canon’s photo cameras and lenses are likewise well respected products in their respective markets. In both business units, Canon has a strong market presence.

I have no doubts in this regard.

While in the printers and peripherals market, Canon is second or third (depending on the year and where rival Epson (ISIN: JP3414750004, Ticker: 6724) lands) behind HP (ISIN: US40434L1052, Ticker: HPQ), it is by far the number one in the market for digital cameras:

source: Statista (see here)

The problem is both, printers and cameras, are markets in secular decline without any meaningful hope for a positive reversal.

Not a favorable situation to be in when those are the pulling horses…

The latter, cameras, even more so as smartphone photography has taken many potential customers / amateur photographers. Point and shoot may not bring the same results like a DSLR camera, but it is decent enough for the majority and clearly more handy to carry around – you likely will always have it with you.

As the saying goes, the best camera is the one you have with you.

And as it seems, all this has been heavily dragging on the stock of Canon.

It has been in decline since its 2008-high (max chart TIKR allows). You can see a bottom in 2020 – the year a bigger reorganization took place – and a decent double since then.

The question down the road will be whether this has been just a “home office rebound” with temporarily higher printer demand or if there’s more in the making.

source: TIKR

While the pro community likely will not switch en masse over to smartphone photography, it won’t be enough to turn this segment into growth mode again. Despite its secular decline, imaging has had the by far strongest operating margins, that’s why lower sales hurt even more.

Until here, we can conclude that 75% of sales are in declining, though not entirely dying markets. You will have noticed two more divisions in the screenshots above: medical systems (since 2017) and industrial.

Medical sells for example MRI, CT, X-ray, ultrasound and other machines, however, it is trailing Siemens Healthiness (ISIN: DE000SHL1006, Ticker: SHL) as well as GE Healthcare (ISIN: US36266G1076, Ticker: GEHC) in many disciplines. In CT, Canon wants to become the leader by 2025.

Sales are rather stable and steadily moving up, but this unit has currently the weakest operating margins – something I would not have expected as its competitors have strong double digit margins. Also, this is a low-growth market, likely not pulling up the whole company.

source: Canon annual report 2022 (see here)

Until here, we have briefly touched upon three of Canon’s four divisions which likely will not ignite a massive fire, assuming sales and operating results won’t drop.

But there’s a new hope: industry has not only become the most profitable segment as of late. This is the jewel with the potential to bring the whole Canon back on track.

We are going to have a closer look at it now.

Canon: a new key semiconductor supplier?

A few weeks ago in mid-October, we had the following alert that for a short time confused one or the other investor of ASML:

source: Seeking Alpha (see here)

In brief, Canon announced the launch of their “NIL” (nanoimprint lithography) technology for the most important production process of semiconductors – the creation of small sized nano-structures on wafers.

Canon’s procedure differs entirely from ASML’s approach, as in this case there is no burning in of the structures via laser light, but they are stamped physically onto the silicon wafers (it’s factually more complicated than just that).

If you’re interested in more background information, Canon has an interview with some employees on its website (see here) as well as an in-depth description of their approach (see here).

Canon itself describes it this way:

In contrast to conventional photolithography equipment, which transfers a circuit pattern by projecting it onto the resist coated wafer, the new product does it by pressing a mask imprinted with the circuit pattern on the resist on the wafer like a stamp. 

source: Canon (see here)

In the past, there have been many quality issues as the physical pressing caused many attempts to fail by damaging or even breaking the elements.

This is said to have been resolved or at least the yields (percentage of elements with satisfactory quality results) are now said to be good enough.

source: Canon (see here)

Canon in its industry segment has until now focused more on machines used to make less advanced chips and also OLED displays. It acquired the US-based nanoimprint pioneer Molecular Imprints Inc. in 2014 and then spent almost a decade on developing this new technology.

As NIL is said to be able to reach first 5nm precision now and later with improvements even 2nm equivalents (compared to ASML) which are needed for the most sophisticated semiconductors, it is understandable that questions arise whether this will be a threat to ASML’s EUV technology.

It is unlikely from the point of view that ASML has not only a proven system in place, compared to a new and potentially uncertain alternative which could disrupt well-running operations and even relationships like the one of Apple, TSMC and ASML (chip designer, producer and equipment manufacturer).

Besides this, ASML’s machines are highly complex, requiring strong business relationships as well as servicing which takes years to develop. This is unlikely to be changed dramatically, especially not from those companies that look at (proven) quality and performance first.

Even Canon’s 88-year old CEO said that this won’t happen.

source: Canon (see here)

The key differentiator will be two other things: the buying price due to less complexity and total cost of ownership, as Canon’s systems will require far less energy.

As to the buying price, even though according to Canon, no final pricing devision has been made, the CEO said the following recently:

The price will have one digit less than ASML’s EUVs.

Canon CEO, quoted by the Financial Post (see here)

And as to the energy demands, Canon had an investor presentation in March 2023 with such a slide. I framed for you the part where they discussed costs.

source: Canon investor presentation, March 2023 (see here)

Above, you can see that energy / power consumption is estimated to be 90% lower when comparing ASML’s EUV and Canon’s NIL.

The first thing that came to my mind was that countries with high energy costs like some in Europe could be potential customers, at least where on- or re-shoring of critical industries takes place – given they will not produce state of the art semiconductors. In the below part, they showed that manufacturing costs will likely also be lower, even though not by 90%.

With the presentation of the Q2 results, during the call a good question was asked (highlight by me):

Q: „When will you commercialize Nanoimprint?“

A: We already have a product ready and are now making adjustments to address customer requests. Demand for this product is expected to be high as a large reduction in cost can be expected compared with conventional lithography equipment, and we expect to reach a certain level of sales volume in 2025.  

source: Canon Q2 2023 conference call (see here)

So, to conclude until here, there have been many announcements as of plans and even technological breakthroughs. We should take serious notice of them.

However, what is missing, are concrete numbers.

It is difficult to estimate what a “certain level of sales volume in 2025” might be.

Another point of uncertainty is the current market environment. Semiconductor demand and investments are weak. Who says that production and deliveries won’t be postponed? ASML, even though having a big backlog, for example has revised its 2024 outlook lower already toward zero growth, even though they said to be conservative.

What I can imagine is that Canon will achieve good results with cost-sensitive customers, potentially even taking some market share where ASML’s DUV (the older generation) machine currently are – but have reached their technological limits.

For ASML this is not a huge problem, as their EUV machine have higher margins.

But there is also the real danger that Canon’s consumer segments start to slide, pushing the whole group down. What I’d prefer is a split of the consumer oriented divisions on one side and an industrial oriented on the other. This way, the potential growth story would not have to work against the big consumer-tech blocks.

Even though valuation multiples do not look high (EV / Sales: 0.9x, EV / FCF around 13x, dividend yield: c. 4%), especially compared to ASML, Canon must ignite its growth engine to justify higher multiples.

With that, I’ll put Canon on my watchlist. It hasn’t fully convinced me.

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Canon is a household name, especially due to its leading consumer tech offerings.

However, they are in secularly declining markets, responsible for 75% of sales.

Canon is trying to transform itself, having a promising industrial business unit. But too many unknowns remain, so it is more a candidate for the watchlist.

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