An under-the-radar AI boom stock

Transistors are now being packaged together into “chiplets”. This means there could be either a graphics processing unit (GPU) or a central processing unit (CPU) connected to a stack of memory chips that have been packaged together. All these chips need to be connected by several tiny wires, and this process is known as advanced packaging.

The demand for advanced packaging is growing rapidly because the super computers training AI programs need high-bandwidth memory (HBW) interfaces. There is no point in having GPUs to do the advanced computing if you can’t transfer data to and from them quickly. The faster the data can be transferred, the faster the models can be trained.

For higher-bandwidth memory, designers have been favouring the 'stacked design'. In this case, several memory chips are stacked on top of one other and then packaged with a GPU or CPU. You can think of this package as a server, and when a bunch of these servers are connected it creates a supercomputer.

The only problem with advanced packaging is that it creates an extra layer of complexity. The need to connect more transistors adds more potential malfunction points. This is where Camtek’s metrology and 3D sensing systems come in. Its sensors, coupled with its software, spot faults and stop manufacturers sending out any broken products.  

Camtek, which is headquartered in Israel and has offices in the US, Germany and Asia, has developed sensors that shine light onto the semiconductors and then analyse what bounces back, similar to sonar. For example, if there is a bump on the transistor, the light might reflect differently. Eventually, by using its proprietary software, its systems can build up a 3D picture of the chip, identify the faults and ultimately improve the yield of the manufacturer.

The main chiplet and high-bandwidth manufacturers are TSMC (TW:2330), Intel (US:INTC), Samsung (KR:005930) and SK Hynix (KR:000660), and while Camtek doesn’t reveal the exact deals it signs, it says that 70 per cent of its business comes from “tier-one manufacturers”. This is good for Camtek because currently all of the above semiconductor manufacturers are being handed cash by governments to expand their production capacity. Intel is building multi-billion-dollar plants in Germany and the US, while TSMC is investing $40bn in Arizona with cash from the US government’s Chips and Science Act.  

Demand could increase "100-fold"

The need for advanced packaging in AI is broker Jefferies’ main thesis for its Camtek buy recommendation. Currently, the advanced packaged CPUs and GPUs are being used in data centres. For example, when someone uses ChatGPT, their request is processed in a data centre and then transmitted back to the desktop or phone. However, Jefferies expects advanced packaging to eventually be used in personal computers, which will lead to a 10-fold expansion in demand.

If advanced packaging is rolled out in smartphones, Jefferies thinks demand could expand to 100 times its current level. “The dream scenario for advanced packaging plays is that the large language models (LLMs) that are being trained today ultimately get inferenced in smartphones,” the brokerage recently wrote. “LLMs with a large number of parameters could require larger chips in smartphones that need advanced packaging, potentially as early as 2025.”

Out of the semiconductor sensing and inspection equipment companies, Camtek has the highest exposure to advanced packaging. In 2022, 55 per cent of its revenue came from the field, compared with 22 per cent at rival Onto Innovation (US:ONTO). This year, the ratio has climbed above 60 per cent, meaning Camtek has the highest exposure of its peers to demand for AI and the tailwinds created from the ramp-up in computing investment from the cloud computing companies, such as Microsoft Azure, Google Cloud and Amazon Web Services.

This thesis is already starting to play out for Camtek. In the third quarter of this year, it received orders for 240 systems, including 28 from “a tier-one customer” for the inspection of HBW and advanced packaging applications.

This is in addition to another 100 HBW systems ordered since the start of July. In total, these orders are worth around $170mn, with $130mn coming from advanced packaging. “The strongest driver, no doubt today is on the advanced packaging part, which is chiplets and HBMs,” said chief financial officer Moshe Eisenberg. “And that’s no doubt a growth driver that is going to be dominant for the next couple years.”

These orders are expected to be booked as revenue in the first half of 2024, leading Jefferies to predict that revenue will grow by 17 per cent in the first half of 2024, on the second half of 2023. For full-year 2024, the broker expects sales to climb 23 per cent, not far off Camtek’s annual growth over the past five years. Between 2017 and 2022, revenue grew from $93mn to $321mn, which is a compound annual growth rate of 28 per cent.

Improving profitability

The benefit of an increasing share of revenue from advanced packaging is that it is more profitable. This has helped Camtek’s operating margin improve from 16 per cent in 2019 to 25 per cent last year. In part, this margin expansion is also to do with economies of scale. For example, since 2019, annual research and development spending has risen 77 per cent but as a percentage of revenue this has fallen from 12 per cent to 9 per cent. As advanced packaging-related sales growth continues, margins should keep expanding. 

Encouragingly, Camtek is good at turning profit into cash. Last year, it generated operating cash flow of $58mn, compared with net income of $80mn, giving it plenty of cash for reinvestment. A month ago, it completed the $100mn acquisition of German metrology business FRT. According to Jefferies, FRT’s customers include Intel and TSMC, which have been using its sensing and detection technology in their advanced packaging plants.

The concern for investors is that the market has already spotted Camtek’s exposure to the AI semiconductor investment boom. So far this year, the share price is up 176 per cent. Back in August when the Investors’ Chronicle mentioned Camtek as an “undiscovered AI play” it was trading at 20 times its forward earnings. Its valuation has since expanded to 27 times, although this is still slightly cheaper than rival Onto’s forward multiple of 31.

This multiple expansion is in part based on the fever for all things AI. In the technology sector, the theme remains inescapable. Microsoft (US:MSFT) is now marketing its 365 Copilot product, which is its AI-enabled version of Microsoft Office, while Amazon (US:AMZN) has just announced its AI chatbot, Q. However, for the tech giants to keep expanding investment in AI servers they will be under to pressure to see returns on investment fast for the momentum to be sustained.

If AI does prove as popular has some believe then the world will need a lot more HBM chips in data centres, desktops and eventually phones. This means more manufacturing equipment and more of Camtek’s detection systems.

At least with Camtek you can guarantee it will turn whatever growth it generates into cash, which isn’t the case with many growth stocks compounding revenue at over 20 per cent year. As a result, the prospective investor isn’t speculating on the quality of Camtek's business – which is certified – but the size of its market.