Despite recent hiccups, tech stocks have experienced sharp rallies in the past 12 months, as investors have sought out companies benefiting from the digital transformation of the global economy. 
In a crowded and expensive tech space, looking beyond the ‘usual suspects’ can make all the difference. Indeed, global equity investors have sometimes overlooked the fact that companies not operating primarily in the digital space can still benefit hugely from the digital transformation, while also enjoying some protection against sudden downturns in tech stocks by virtue of their diversification. This is especially notable in the increasingly popular semiconductors space.
Two Japanese semiconductor plays not classified as technology stocks are Hoya Corporation, a healthcare company, and Shin-Etsu Chemical, a materials producer.
These companies have built dominant positions in targeted areas of the semiconductor value chain while also offering investors diversification benefits should the digital trend reverse temporarily. Yet, because they are not properly understood as tech plays, these companies trade at lower multiples than their better-known peers despite enjoying earnings growth and margins that are at least as high as the rest of the sector’s.
ESG criteria should be integrated in all stock selection and companies in the semiconductor arena can pose challenges especially when it comes to environmental concerns. Therefore a thorough review and careful screening is needed to ensure that the companies are in line with ESG standards. It’s always of paramount importance for active investors to engage with portfolio companies and where necessary engage with them to improve their ESG performance.
Hoya Corporation began operations as a glassware company, and it has parried its core strength in glass processing into near dominance in disc substrates and semiconductor imaging materials. Although Hoya derives over 60 per cent of its sales from its lifecare business, approximately 20 per cent of its profits come from its role in the semiconductor supply chain.
The company is the global leader in photoblanks and photomasks, a niche but highly profitable area – operating margins are over 50 per cent. Hoya’s sales of Extreme Ultraviolet (EUV) components for the latest generation of semiconductor chips have increased by more than 50 per cent annually over the past couple of years. Hoya should continue to grow dynamically over the next several years, led by the company’s clear leadership in blanks and masks for the leading edge.
In terms of ESG Hoya stands out among Japanese companies for its corporate governance structure. The company has three board committees (audit, nomination, compensation) which are fully independent. Moreover, the board is majority independent as it comprises five independent outside directors and only one executive officer, who is actually the CEO/chairman.
As regards environmental risks, producing glass is not only a highly energy-intensive activity, but water intensive as well (and comes with the risk of water pollution). As such Hoya is vulnerable to risks from high water consumption (i.e. droughts), as well as climate change-related risks like massive flooding in Thailand and the Philippines where some Hoya plants are located.
In 2019 and 2020, we led a collaborative investor initiative (CDP Non-Disclosure Campaign) to encourage the company to increase its environmental disclosure, which has since then been implemented: Hoya decided to report on CDP Climate Change and Water Security questionnaires. We continue to engage with them with positive results and Hoya now provides more disclosure on ESG matters and metrics.
Shin-Etsu Chemical has also built an almost unassailable position supplying essential components to the semiconductor industry. It is not well known outside Japan and even less well known as a tech play. Yet it is the global leader in the manufacture of semiconductor wafers (on which circuits are printed) with a 30 per cent market share, a highly attractive business with returns on invested capital (ROIC) of over 20 per cent and double-digit earnings growth.
The company is protected by significant barriers to entry, meaning that its returns are sustainable: it is a scale business as it takes at least two to three years to build a greenfield plant and even longer to build client trust. Demand for 300-millimetre wafers for use in smartphones, data centres and other applications is set to rise faster than supply for some time, boosting both volumes and pricing at Shin-Etsu. Shin-Etsu should be able to generate double-digit annualized earnings growth over the next 5 years, bolstered by a continuation of these trends.
Although Shin-Etsu faces significant environmental issues it provides a good level of ESG information disclosure. Sustainable development is visibly embedded into their corporate strategy and they are actively addressing the 10 most prioritised Sustainable Development Goals (SDGs) for the chemical sector. Their ESG Promotion Committee is chaired by the company’s president and has identified key issues for the company to address and established targets. The firm has also been included in various CSR indices such as: MSCI ESG Leaders, MSCI Japan ESG Select Leaders, FTSE4Good and FTSE Blossom Japan among others.
Of course, this is not to say investors ought to avoid better known companies.
In the semiconductor space Taiwan Semiconductor Manufacturing Company (TSMC), a multinational semiconductor contract manufacturing and design company, remains a strong quality growth stock.
However, investors should not lose sight of the fact that the secular growth trends underpinning tech plays are actually supporting a diverse range of companies, not all of them well known or understood as technology stocks. It is always worth casting the net wide and looking to see who stands to benefit from digital transformation, even if their main line of business is elsewhere.
Laure Negiar is portfolio manager of the Comgest Global Growth strategy. The views expressed above are her own and should not be taken as investment advice.