đ usncan Note: AI Tailwinds & A Cheap Stock
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Close-up of Silicon Die are being Extracted from Semiconductor Wafer and Attached to Substrate by Pick and Place Machine. Computer Chip Manufacturing at Fab. Semiconductor Packaging Process.
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The U.S. GDP grew 3% in the second quarter of 2025, which exceeded expectations. However, tariff uncertainty clouds the headline growth figure. The majority of the improvement was driven by a large decline in imports, particularly after a record surge in imports in 1Q25.
One area that hasnât slowed, regardless of the headlines or tariff polices: Artificial Intelligence. Companies are still investing billions in the space, each hoping to carve out their place in the trillion-dollar industry. Anthropic is reportedly raising $5 billion in a new round of funding that would value the company at $170 billion, up from $62 billion earlier this year.
With billions flowing into the industry and driving up valuations, there couldnât possibly be any stocks in the AI space that still look cheap, right? Wrong.
My latest Long Idea is a great example of the edge that superior fundamental research provides. This company is an industry leader, benefits from AI tailwinds, has strong fundamentals, and its stock looks undervalued.
I originally made Photronics (PLAB) a Long Idea in October 2023 and most recently reiterated my thesis in February 2024.
PLAB offers favorable Risk/Reward based on the companyâs:
- position to profit from AI-driven tailwinds,
- shifting revenue mix to higher value products,
- high profitability, and
- cheap stock valuation.
Whatâs Working
AI Is Driving Photomask Demand
As a leading photomask manufacturer, Photronics is well-positioned to profit from the photomask demand growth driven by advancements in each of these three key areas:
- chip technology â smaller integrated circuits require higher value photomasks,
- capacity expansions â more chips mean higher photomask demand, and
- consumer electronics â improved screens and more (advanced) chips drive photomask demand.
SEMI projects global semiconductor manufacturing capacity to grow 7% compounded annually from the end of 2024 through 2028.
Additionally, according to the Semiconductor Industry Association (SIA), global semiconductor sales grew 20% year-over-year in May 2025 and 3.5% month-over-month (MoM).
Longer-term, the global semiconductor market will grow 8% compounded annually from 2025 to 2034, according to Precedence Research. The long-term outlook for semiconductor demand indicates Photronics will have ample growth opportunities.
Figure 1: Global Semiconductor Market Size: 2024 â 2034
Semiconductor Market Forecast 2024-2034
Precedence Research
Advanced chipmaking catered to the growing needs of AI applications is a key driver of the projected semiconductor market and capacity growth. AI chips require increased computational abilities, specialized processes, and specific energy needs. Advanced semiconductor technology demand is expected to remain strong, as AI (and its specific chips) gets integrated at a rising rate across many consumer electronics, from phones to computers, vehicles and smart devices (such as smart speakers).
Increasingly Positioned to Take Advantage of the AI Boom
Many technology companies are rushing to take advantage of growing AI demand, from producing the hardware to creating AI products. Photronics capitalizes on the AI boom across industries.
More specifically, Photronics produces two types of photomasks for integrated circuits (âICâ): high-end and mainstream. AI-driven technologies require the high-end photomasks (with IC nodes at 28 nanometers or smaller) and represent a key tailwind for Photronicsâ growth.
These high-end products require more photomasks per design and generate higher average selling prices per mask set.
Historically, mainstream IC photomasks have, and continue to, make up a majority of the companyâs IC photomask revenue mix.
However, Photronics has grown its high-end business from 30% of overall IC revenue in fiscal 2023 to 39% of IC revenue in the first half of fiscal 2025 (1H25). See Figure 2.
Figure 2: High-End IC Revenue as % of IC Revenue: Fiscal 2023 â 1H25
PLAB High End IC Revenue 2023-1H25
New Constructs, LLC
Geographic Footprint Minimizes Tariff Impact
Photronics operates 11 production facilities across Asia, the United States, and Europe. These facilities are located close to customers, which allow Photronics to more quickly collaborate and build products that meet its customerâs needs.
These locations also create a tariff advantage, especially after âLiberation Dayâ, when President Trump announced tariffs against individual countries.
On one hand, with three facilities in the United States, Photronics stands to benefit from the reshoring of semiconductor production. To maximize the benefit, Photronics is expanding its capacity and capabilities in the United States through strategic investments.
For those customers that arenât reshoring production, Photronics allocates production across its facilities to ship âthe majority of masksâ directly to customers in the same region or country where the photomasks are produced, which mitigates the potential tariff costs for its customers.
In the companyâs 2Q25 earnings call, management noted that the impact of tariffs on its supply chain âwill have a negligible impactâ to its financial results.
Quality Fundamentals
Apart from industry tailwinds and growing competitive advantages, Photronics has also grown revenue and Core Earnings, a superior metric of earnings, by 6% and 25% compounded annually since fiscal 2014, respectively. See Figure 3.
The company improved its net operating profit after-tax (NOPAT) margin from 5% in fiscal 2014 to 19% in the TTM while invested capital turns increased from 0.5 to 0.6 over the same time. Rising NOPAT margins and invested capital turns drive return on invested capital (ROIC) from 2% in fiscal 2014 to 12% in the TTM.
Additionally, the companyâs NOPAT grew 21% compounded annually from $22 million in fiscal 2014 to $163 million in the TTM.
Figure 3: Photronicsâ Revenue and Core Earnings Since Fiscal 2014
PLAB Revenue & NOPAT 2014-TTM
New Constructs, LLC
Strong Cash Flow Generation
I believe Photronics can continue to repurchase shares because of its large free cash flow (FCF). From fiscal 2020 through fiscal 2Q25, Photronics generated $415 million in FCF, which equals 37% of the companyâs enterprise value.
Photronicsâ $415 million in FCF since fiscal 2020 is more than enough to cover its $145 million in share repurchases.
Figure 4: Photronicsâ Cumulative FCF: Fiscal 2020 â TTM
PLAB Free Cash Flow 2020-1H25
New Constructs, LLC
Industry Leading Profitability
Photronics, with its position as an industry leader, is also one of the most profitable companies in the industry.
Most of Photronicsâ competitors are private or trade outside the United States. As a result, I compare the companyâs profitability to the peers listed in its proxy statement.
Per Figure 5, Photronics has the second highest NOPAT margin and the fourth highest ROIC among its peers, which include Cirrus Logic (CRUS), FormFactor (FORM), Power Integrations (POWI), Entegris (ENTG), Kulicke & Soffa Industries (KLIC), and more.
Figure 5: Photronicsâ Profitability Vs. Peers: TTM
PLAB Profitability vs. Peers
New Constructs, LLC
Potential Repurchase Yield of 1.8%
Photronics currently doesnât pay any dividends but does return capital to shareholders through share repurchases.
From September 2020 through October 2022, the company repurchased $68 million of shares. In August 2024, the companyâs Board of Directors authorized an increase to the share repurchase program, which allows the company to repurchase up to $100 million of shares.
In the six-months ended May 4, 2025 (fiscal 1H25), the company repurchased $77 million (6% of market cap) of shares. As of May 4, 2025, $23 million of shares remained under the current authorization. Should the company repurchase shares at its fiscal 1H25 rate, it would exhaust the remaining authorization, which equals 1.8% of the current market cap.
Should the companyâs Board authorize additional repurchases, the repurchase yield could be even higher.
Whatâs Not Working
Ongoing Tension with China Creates Uncertainty
Tariff uncertainty, especially about China, looms large for many international operators. In the first half of fiscal 2025, Photronics earned 27% of its revenue in China.
Investors are waiting for any announcement regarding an extension of the ongoing tariff pause between the U.S. and China. Without an extension, tariff rates will rise to Liberation Day highs and would likely impact trade between the two countries in a material way. Meanwhile, should President Trump extend the current pause, or sign a long-term deal, the uncertainty in the market would dissipate quickly.
However, as I mentioned earlier, I donât expect tariffs to impact Photronicsâ business in a material way, thanks to the companyâs diversified geographic footprint.
Customer Concentration Risk
In fiscal 2024, Photronics generated 36% of its revenue from three customers. This concentration should not be a big concern, given that the semiconductor industry is very top heavy, but it is worth noting.
If any issues were to arise, either with a customerâs ability to operate or the relationship between the customer and Photronics, the impact could be material. Prudent investors should account for this risk when valuing PLAB.
The good news for investors is that Photronicsâ stock price already implies a permanent drop in profits, as Iâll show below.
Current Price Implies Profit Permanently Declines by 20%
At its current price of $21/share, PLAB has a price-to-economic book value (PEBV) ratio of 0.8. This ratio means the market expects the companyâs profits to permanently decline 20% from TTM levels. For context, Photronics has grown NOPAT by 27% compounded annually over the last five years and 21% compounded annually over the last decade.
Below, I use my reverse discounted cash flow (DCF) model to analyze expectations for different stock price scenarios for PLAB.
In the first scenario, I quantify the expectations baked into the current price. If I assume:
- NOPAT margin immediately falls to 13% (below five-year average of 15% and TTM NOPAT margin of 19%) through 2034, and
- revenue grows 3% a year through 2034 (compared to 8% CAGR over the last five years and 6% CAGR over the last decade) then
the stock would be worth $21/share today â equal to the current stock price. In this scenario, Photronicsâ NOPAT would fall 1% compounded annually from 2025 â 2034, which is far below the companyâs historical NOPAT growth rates.
Shares Could Go 29%+ Higher at Consensus Growth Rates
If I instead assume:
- NOPAT margin falls to 18% (below TTM NOPAT margin of 19%) through 2034,
- Revenue grows at consensus estimates in 2025 (-4%) and 2026 (6%), and
- revenue grows 3% a year through 2034 (compared to 8% CAGR over the last five years and 6% CAGR over the last decade) then
the stock would be worth $27/share today â a 29% upside to the current price. In this scenario, Photronicsâ NOPAT would grow just 2% compounded annually through fiscal 2034, which would still be below the companyâs historical growth rates dating back to 1998.
Should NOPAT grow closer to historical rates, the upside would be even larger.
Figure 6 compares Photronicsâ historical NOPAT to the NOPAT implied in each of the above scenarios.
Figure 6: Photronicsâ Historical and Implied NOPAT: DCF Valuation Scenarios
PLAB DCF Implied NOPAT Scenarios
New Constructs, LLC
