Earlier in the year, most of the expert opinion on the Zacks Semiconductor Equipment – Wafer Fabrication industry was negative.

This was proved wrong when the whole world went digital in order to avoid the pandemic and increase social distancing. So working, studying, playing, exercising, entertaining and connecting moved to digital channels. While some of this may revert when the situation improves, it’s clear that many of the trends set by the pandemic will last.

It’s typically in situations like these, when there’s a sustained higher level of semiconductor demand, that semiconductor manufacturers add capacity or fabrication facilities. And that then leads to the increased investment in wafer fab equipment that we are seeing today.

With valuations also dropping as a result of unrelated factors moving the markets, stocks like Applied Materials (AMAT Quick QuoteAMAT - Free Report) and Advanced Energy Industries (AEIS Quick QuoteAEIS - Free Report) are looking quite attractive.

About The Industry

Wafer fabrication is a process during which a silicon wafer (usually 200mm or 300mm in size) is treated with successive layers of conductive and semiconductive material using stencil-like structures called reticles. After each deposition of material on the surface, the excess material is etched away and the wafer exposed to a light source to implant the design. This is the front end process. The back end process is involved in cutting up the individual die, packaging for protection and use, attaching of electrical leads and sorting.

So wafer fab equipment demand is dependent on the level of demand for semiconductors on the one hand and the level of installed capacity on the other.

Semiconductor demand primarily comes from cloud (COVID-related acceleration), PCs (COVID-related acceleration), smartphones (demand is moderating), IoT (demand remains strong), automotive (remains muted), artificial intelligence, HPC, communications infrastructure (5G, although there were some builds toward the end of 2019).

Researchers have updated their forecasts for the wafer fab equipment spending environment.

Accordingly, Gartner is forecasting a 4.5% increase in WFE spending in 2020 (previous expectation was for a 14.9% decline) following the 5.9% decline in 2019. Strength will be driven by heavy spending on leading edge logic at foundries and Chinese memory. Major memory producers will ramp spending in 2021 when the industry will grow 3.8%.

SEMI expects 6.0% WFE spending growth in 2020 (previous expectation was 3% growth) followed by 10.8% growth in 2021 (previous 14%). The number includes wafer processing, fab facilities, and mask/reticle equipment, which will grow 5% in 2020 and 13% in 2021; foundry and logic equipment, which will grow single-digits in both years; DRAM and NAND up slightly in 2020 and 20%+ in 2021; assembly and packaging to grow 10% and 8%, respectively; and test equipment to grow 13% this year with sustained momentum in 2021.

While China will be the top spender in both years, 2021 level will be lower than 2021. All other regions will grow in both years. Taiwan will be the second largest spender, followed by Korea, which will be particularly strong next year with the pickup in memory.

 IC Insights estimates that installed capacity will take care of DRAM demand this year. It’s forecasting a 21% cut in spending at Samsung (the largest), a 38% cut at Hynix (second largest producer) and 16% cut at Micron, which is the third largest.

Factors Shaping The Industry

• COVID has been both good and bad for the semiconductor industry, since it pushed up demand in some segments while depressing demand in others. Researchers are finally in agreement about the positive overall impact. This is not only because of the surge in semiconductor demand, which has a direct impact on the industry, but also the fact that the manufacturing operations have suffered less than the services segment during this crisis. So churning out the necessary volumes has not been an issue.

• Semiconductor demand is the primary driver of equipment purchases, although new fabs also play a big role. SEMI says that 369 fabs are in equipping mode, of which 32 new fabs will be equipping this year, followed by 15 in 2021. Equipment demand tends to be relatively stable in times of short-term challenges because these are made with a longer-term objective. Memory typically makes up the largest part of WFE spending, so spending cuts at the three major memory makers is a negative.

• China continues to play a big role (as both consumer and manufacturer) because of the government’s initiative to make the country a major producer of semiconductors. While there are political pressures from across the world, particularly from the U.S., the Chinese are very determined to get there and have their own global relationships and partners. America’s opposition to China’s stated goals is increasing uncertainty.

• Technology transitions, an important consideration for equipment purchases, will continue to respond to the move toward larger wafer sizes (fab upgrades to 300mm, as well as continued demand for 200mm), shrinking nodes (sub 10nm), memory chip advancements (3D NAND processes are maturing, driving down cost), denser packaging (MEMS) and so forth. Materials research, device complexities, the need for greater manufacturing integration and new applications are also important.

Zacks Industry Rank Suggests Bright Prospects

The Zacks Semiconductor Equipment -Wafer Fabrication Industry is a stock group within the broader Zacks Computer And Technology Sector. It carries a Zacks Industry Rank #64, which places it in the top 25% of more than 250 Zacks industries.

Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. So the group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued stability going forward.

The industry’s positioning in the top 25% of Zacks-ranked industries is a result of the strength in the 2020 earnings outlook of constituent companies in aggregate. Despite ta dip in expectations during the months of March through June due to the COVID crisis, expectations have bounced back pretty strongly. Consequently, the industry’s aggregate earnings estimate revision for 2021 is up 7.2% from Oct 2019, with the rebound expected to continue thereafter.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Outperforming on Shareholder Returns

After dipping below the S&P 500 as well as the Computer And Technology Sector in March, the Zacks Semiconductor-Wafer fab Equipment Industry pulled ahead of both. However, the September dip has now put it behind the sector, although it still remains ahead of the S&P 500.

So we see that the stocks in this industry have collectively gained 17.1% over the past year, while the Zacks S&P 500 Composite and Zacks Computer and Technology Sector gained 4.5% and 22.1%, respectively.

While the industry is small, players like Applied Materials, Lam Research (LRCX Quick QuoteLRCX - Free Report) and ASML Holding NV (ASML Quick QuoteASML - Free Report) are very important players. 

One-Year Price Performance

Industry’s Current Valuation

On the basis of the forward 12-month price-to-earnings (P/E) ratio, which is a commonly used method of valuing semiconductor equipment companies, we see that the industry is currently trading at 22.10X, which is above the S&P 500’s 21.96X and below the sector’s forward-12-month P/E of 26.18X.

Over the past year, the industry has traded as high as 25.36X, as low as 18.64X and at the median of 21.96X, as the chart below shows.

Forward 12 Month Price-to-Earnings (P/E) Ratio

2 Stocks to Ride the Boom

Following the September slowdown, the election overhang and other near-term uncertainties, valuations have started to look better for stocks in this industry. So here are a couple that you could use to capitalize on the impending growth-

Applied Materials (AMAT Quick QuoteAMAT - Free Report) : This Zacks Rank #2 company is one of the world’s largest suppliers of fabrication equipment for semiconductors, flat panel liquid crystal displays (LCDs), and solar photovoltaic (PV) cells and modules.

The Zacks Consensus Estimates for 2020 and 2021 earnings are up a respective 6.8% and 9.5% in the last 60 days.

The shares have appreciated 23.9% over the past year.

Being one of the leading players in the semi equipment space with major customers across important markets, the company is a beneficiary of strengthening demand in the industry, especially in the red-hot China market.

Price and Consensus: AMAT

 

Advanced Energy Industries (AEIS Quick QuoteAEIS - Free Report) : AEIS is a leading supplier of power subsystems and process-control technologies to the semiconductor, medical, industrial, data center, telecom and networking equipment segments.

With This Zacks Rank #2 company has gained 25.9% over the past year. The Zacks Consensus Estimate for the 2020 EPS is up 31 cents (7.7%) in the last 7 days. The estimate for 2021 also jumped 24 cents (5.2%) 7 days ago.

The increased complications of making smaller and more integrated semiconductor devices (the market contributes over half its revenue), increasing data center usage as a result of the pandemic and particularly at hyperscale customers (nearly 12% of revenue) are current drivers of AEIS solutions. Its other segments may be seeing a mixed impact from the pandemic (strength in medical critical care and 5G somewhat moderated by slowdown in other medical and other telecom). However, power management and process control help to lower cost, so demand for these solutions is likely to be sustained.

Price and Consensus: AEIS

 

More Stock News: This Is Bigger than the iPhone!

It could become the mother of all technological revolutions. Apple sold a mere 1 billion iPhones in 10 years but a new breakthrough is expected to generate more than 27 billion devices in just 3 years, creating a $1.7 trillion market.

Zacks has just released a Special Report that spotlights this fast-emerging phenomenon and 6 tickers for taking advantage of it. If you don't buy now, you may kick yourself in 2021. 

Click here for the 6 trades >>