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The primary drivers of wafer fab equipment (WFE) demand are the strength of semiconductor demand and the existing capacity level. Other factors, such as constraints on selling semiconductors to China, the possibility of a recession, inflationary pressures and rising interest rates that impact consumer spending, or the diversion of consumer funds to leisure and/or travel activity affect one or both of the primary factors.
Estimates from Gartner on global semiconductor demand reflect these concerns. The research firm estimates that semiconductor revenue grew a mere 1.1% in 2022 versus its 7.4% estimate. And this estimate is down from 13.6% growth expected earlier. The expected decline in 2023 revenue is now 3.6%, which is down more than a percentage point from the prior estimate of 2.5%.
Gartner does, however, say that the weakness is on the memory side where an inventory glut is leading to weak pricing. Memory demand is more dependent on consumer and computing gadgets, which makes it somewhat dependent on consumer purse strings. Enterprise demand is expected to hold up better, despite concerns related to the slowing economy because companies generally invest for the long term and place their orders well in advance. Additionally, because of the length of equipment sales cycles, short-term concerns usually don’t hurt the outlook immediately.
Gartner expects 2022 semi equipment spending to increase 18% with related service revenue growing 24%. The 2023 estimate is not available yet.
After three solid years, SEMI expects semiconductor manufacturing equipment revenue to decline 15.9% in 2023. This is mainly on account of WFE, which is expected to decline 16.8% this year before rebounding 17.2% in 2024. Foundry and logic (accounting for over half the shipments) will decline 9% in 2023.
Back-end equipment, including testing, assembly and packaging are expected to decline double digits this year followed by double-digit growth in the next. The decline in spending will be broad-based across most geographies although China is expected to be the largest spender this year with Taiwan regaining the top spot next year.
Social distancing and the at-home economy have accelerated digitization, driving up chip demand. And digitization has become a broader trend as companies prioritize their technology investments. Developments in auto, industrial, clean energy, IoT, healthcare, online services and defense segments are positive for long-term semiconductor demand, and in turn, for equipment spending.
A number of countries are moving to onshore semiconductor production as a strategic necessity, which is also a long-term positive for equipment demand.
Despite this underlying strength, macro and geopolitical considerations, including restrictions on trading with China are likely to weigh on stocks like ASML Holding (ASML - Free Report) and Lam Research (LRCX - Free Report) .
About the Industry
Industry players offer wafer fabrication equipment and services. Wafer fabrication involves the treatment of a silicon wafer (usually 200mm or 300mm in size) to 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. The back-end process involves cutting up the individual die, packaging for protection/use, attachment of electrical leads and sorting.
The industry depends on semiconductor demand, which primarily comes from cloud (growth is decelerating), ecommerce (relative softness), PCs (post-pandemic adjustments continue), smartphones (moderating demand), IoT (strong demand), automotive and industrial (relatively steady), AI and HPC (strong), comm infrastructure.
Factors Shaping the Industry
New export regulations are one of the biggest concerns right now. The increasing polarization between the two largest economies makes this a longer-term concern. Of course, China will only use foreign equipment/chips/resources until it can make its own. Therefore, business that would have gone away several years down the line now looks set to disappear right away. Semi equipment makers do substantial business in China, so the separation will be painful.
Successive rate hikes have not had the desired effect on inflation in most industries, mainly because of strength in labor markets. Until the labor market weakens sufficiently, the rate hikes and energy cost inflation will only increase input cost, offsetting the relief from supply chains normalizing. And in case the labor markets soften and we do enter a recession, demand for several end devices that use semiconductors will be hit. Rate hikes also affect other economies, leading to a global slowdown. This hurts semiconductor companies and equipment makers on account of their being global players.
Geopolitical tensions continue to simmer all over the world. There is the Ukraine war that is a general negative for the industry, especially those making equipment using neon and other gases the bulk of which are produced in the Ukraine and Russia. The threat of nuclear war is an added concern. China removing draconian COVID restrictions is a plus, but its increasing possessiveness about Taiwan is not. This is a big concern for the semiconductor industry in particular, given the amount of production that happens in the region. There is the financial crisis in the UK and several other countries, some of which appear to be going under. There is inflation the world over. This kind of upheaval is not positive for economic growth that can spur semiconductor demand. That said, the increasing use of electronics in communications and defense, and their role in helping companies to pull out of the mess means that semiconductor demand is likely to suffer less in the face of a global meltdown.
Semiconductor demand is the primary driver of equipment purchases, although new fabs also play a big role. In fact, many new fabs are expected to come online over the next decade, which is a big positive for long term WFE demand. In the short term, however, it’s a concern that memory typically makes up the largest part of WFE spending, because that’s the segment with the inventory glut and the resultant price weakness.
Technology transitions, such as the move toward larger wafer sizes (fab upgrades to 300mm, plus 200mm demand), shrinking nodes (7nm and below), memory chip advancements (4D NAND as increasing layers are adding complexity), denser packaging (MEMS), etc. Materials research, device complexities, the need for greater manufacturing integration and new applications are also important factors. Other inflections will· come from new chip architectures like workload-specific ASICs; next-generation 4D NAND; new materials in gate, contact and interconnect; advanced patterning; and advanced packaging. The increased complexity of building modern chips is good for equipment makers.
Zacks Industry Rank Indicates Some Near-term Uncertainty
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, is a positive.
The industry’s positioning in the top 50% of Zacks-ranked industries is because the earnings outlook of constituent companies in aggregate has remained relatively steady since last October. However, the industry’s aggregate earnings estimate revision for 2023 represents a 19.6% decline from Jan 2022. The 2024 revision amounts to a 12.0% decline from January although there’s an increase of 1.7% from October.
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 Lagging on Shareholder Returns
The Zacks Semiconductor-Wafer fab Equipment Industry has traded at a discount to the S&P 500 through the past year and also dropped below the broader technology sector at times. But it has moved up since October and is currently trading at a premium to both the industry and the S&P 500. The industry’s long-term prospects and the relative stability that comes from the long sales cycles and contracts makes it attractive in uncertain times.
So we see that the stocks in this industry have collectively lost 7.8% over the past year, while the S&P 500 Composite lost 11.1% and the Zacks Computer and Technology Sector 21.7%.
One-Year Price Performance
Image Source: Zacks Investment Research
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 23.76X, close to its high point of 23.92X relatively close to the sector’s 22.18X multiple. It is however well above the S&P 500’s 18.29X.
Over the past year, the industry has traded as high as 23.92X, as low as 14.87X and at a median of 20.17X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
2 Stocks with Good Longer-term Prospects
With the pandemic in the rearview mirror, it’s understood that the huge boost in semiconductor sales from the operating-from-home economy will not repeat, although the hybrid mode of operation has longer-term positive implications for the semiconductor and allied industries. Semiconductor demand will also be boosted by their expanding application across sectors and production in new geographies (given their strategic value).
Equipment demand is more stable than chips, because semiconductor manufacturing equipment is high-value and so, a part of the long-term planning process. That said, geopolitical tensions may disrupt the supply chain and increase cost, which will impact profitability.
Given the somewhat mixed prospects, all of the stocks in this industry currently have a #3 (Hold) rating. Below, we are taking a closer look at two of them:
ASML Holding NV (ASML - Free Report) : This is one of the world’s largest suppliers of advanced semiconductor equipment consisting of lithography, metrology and inspection systems for memory and logic chipmakers.
Management has said that while there is continued uncertainty on account of inflation, rising interest rates, risk of recession and geopolitical developments related to export controls, customer optimism for a rebound in the second half, the typically long lead times and the strategic nature of lithography investments add up to continued strength in 2023.
The Zacks Consensus Estimate for 2023 has dropped in the last seven days, but remains above the levels estimated 60 days ago. The Zacks Consensus Estimate for 2024 has increased consistently in the last 30 days. Despite the fact that geopolitical concerns are considerable for ASML, analysts are highly optimistic. In fact this is the only equipment company that is expected to generate strong double-digit growth rates in both 2023 and 2024.
The shares are down 3.5% over the past year.
Price and Consensus: ASML
Image Source: Zacks Investment Research
Lam Research Corp. (LRCX - Free Report) : Lam Research is a global supplier of wafer fabrication equipment and services to the semiconductor industry. Its primary focus is the memory segment from which it generates 60% of its revenue. The rest is roughly even between foundry and logic. It is highly exposed to China, generating over 30% of revenue from the region.
Lam had a strong 2022, but is headed into a challenging 2023, as equipment spending is set to plunge in the March quarter due to an inventory correction, particularly in the NAND and DRAM memory segments, to which it is highly exposed. Trade restrictions with China are also an overhang. The rest of the year is likely to be relatively flat and the longer-term outlook is of course excellent. Semiconductor content increases in existing devices and increased application in several markets, rising device complexity and larger die sizes remain long-term positives.
This stock has lost 18.3% of its value over the past year. The Zacks Consensus Estimate for 2023 (ending June) earnings is down 1.1% in the last 60 days. The estimate for 2024 is up 2.3%.
Price and Consensus: LRCX
Image Source: Zacks Investment Research
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Not the Best Time for the Semi Equipment Industry
The primary drivers of wafer fab equipment (WFE) demand are the strength of semiconductor demand and the existing capacity level. Other factors, such as constraints on selling semiconductors to China, the possibility of a recession, inflationary pressures and rising interest rates that impact consumer spending, or the diversion of consumer funds to leisure and/or travel activity affect one or both of the primary factors.
Estimates from Gartner on global semiconductor demand reflect these concerns. The research firm estimates that semiconductor revenue grew a mere 1.1% in 2022 versus its 7.4% estimate. And this estimate is down from 13.6% growth expected earlier. The expected decline in 2023 revenue is now 3.6%, which is down more than a percentage point from the prior estimate of 2.5%.
Gartner does, however, say that the weakness is on the memory side where an inventory glut is leading to weak pricing. Memory demand is more dependent on consumer and computing gadgets, which makes it somewhat dependent on consumer purse strings. Enterprise demand is expected to hold up better, despite concerns related to the slowing economy because companies generally invest for the long term and place their orders well in advance. Additionally, because of the length of equipment sales cycles, short-term concerns usually don’t hurt the outlook immediately.
Gartner expects 2022 semi equipment spending to increase 18% with related service revenue growing 24%. The 2023 estimate is not available yet.
After three solid years, SEMI expects semiconductor manufacturing equipment revenue to decline 15.9% in 2023. This is mainly on account of WFE, which is expected to decline 16.8% this year before rebounding 17.2% in 2024. Foundry and logic (accounting for over half the shipments) will decline 9% in 2023.
Back-end equipment, including testing, assembly and packaging are expected to decline double digits this year followed by double-digit growth in the next. The decline in spending will be broad-based across most geographies although China is expected to be the largest spender this year with Taiwan regaining the top spot next year.
Social distancing and the at-home economy have accelerated digitization, driving up chip demand. And digitization has become a broader trend as companies prioritize their technology investments. Developments in auto, industrial, clean energy, IoT, healthcare, online services and defense segments are positive for long-term semiconductor demand, and in turn, for equipment spending.
A number of countries are moving to onshore semiconductor production as a strategic necessity, which is also a long-term positive for equipment demand.
Despite this underlying strength, macro and geopolitical considerations, including restrictions on trading with China are likely to weigh on stocks like ASML Holding (ASML - Free Report) and Lam Research (LRCX - Free Report) .
About the Industry
Industry players offer wafer fabrication equipment and services. Wafer fabrication involves the treatment of a silicon wafer (usually 200mm or 300mm in size) to 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. The back-end process involves cutting up the individual die, packaging for protection/use, attachment of electrical leads and sorting.
The industry depends on semiconductor demand, which primarily comes from cloud (growth is decelerating), ecommerce (relative softness), PCs (post-pandemic adjustments continue), smartphones (moderating demand), IoT (strong demand), automotive and industrial (relatively steady), AI and HPC (strong), comm infrastructure.
Factors Shaping the Industry
Zacks Industry Rank Indicates Some Near-term Uncertainty
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 #94, which places it in the top 38% of nearly 250 Zacks-classified 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, is a positive.
The industry’s positioning in the top 50% of Zacks-ranked industries is because the earnings outlook of constituent companies in aggregate has remained relatively steady since last October. However, the industry’s aggregate earnings estimate revision for 2023 represents a 19.6% decline from Jan 2022. The 2024 revision amounts to a 12.0% decline from January although there’s an increase of 1.7% from October.
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 Lagging on Shareholder Returns
The Zacks Semiconductor-Wafer fab Equipment Industry has traded at a discount to the S&P 500 through the past year and also dropped below the broader technology sector at times. But it has moved up since October and is currently trading at a premium to both the industry and the S&P 500. The industry’s long-term prospects and the relative stability that comes from the long sales cycles and contracts makes it attractive in uncertain times.
So we see that the stocks in this industry have collectively lost 7.8% over the past year, while the S&P 500 Composite lost 11.1% and the Zacks Computer and Technology Sector 21.7%.
One-Year Price Performance
Image Source: Zacks Investment Research
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 23.76X, close to its high point of 23.92X relatively close to the sector’s 22.18X multiple. It is however well above the S&P 500’s 18.29X.
Over the past year, the industry has traded as high as 23.92X, as low as 14.87X and at a median of 20.17X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
2 Stocks with Good Longer-term Prospects
With the pandemic in the rearview mirror, it’s understood that the huge boost in semiconductor sales from the operating-from-home economy will not repeat, although the hybrid mode of operation has longer-term positive implications for the semiconductor and allied industries. Semiconductor demand will also be boosted by their expanding application across sectors and production in new geographies (given their strategic value).
Equipment demand is more stable than chips, because semiconductor manufacturing equipment is high-value and so, a part of the long-term planning process. That said, geopolitical tensions may disrupt the supply chain and increase cost, which will impact profitability.
Given the somewhat mixed prospects, all of the stocks in this industry currently have a #3 (Hold) rating. Below, we are taking a closer look at two of them:
ASML Holding NV (ASML - Free Report) : This is one of the world’s largest suppliers of advanced semiconductor equipment consisting of lithography, metrology and inspection systems for memory and logic chipmakers.
Management has said that while there is continued uncertainty on account of inflation, rising interest rates, risk of recession and geopolitical developments related to export controls, customer optimism for a rebound in the second half, the typically long lead times and the strategic nature of lithography investments add up to continued strength in 2023.
The Zacks Consensus Estimate for 2023 has dropped in the last seven days, but remains above the levels estimated 60 days ago. The Zacks Consensus Estimate for 2024 has increased consistently in the last 30 days. Despite the fact that geopolitical concerns are considerable for ASML, analysts are highly optimistic. In fact this is the only equipment company that is expected to generate strong double-digit growth rates in both 2023 and 2024.
The shares are down 3.5% over the past year.
Price and Consensus: ASML
Image Source: Zacks Investment Research
Lam Research Corp. (LRCX - Free Report) : Lam Research is a global supplier of wafer fabrication equipment and services to the semiconductor industry. Its primary focus is the memory segment from which it generates 60% of its revenue. The rest is roughly even between foundry and logic. It is highly exposed to China, generating over 30% of revenue from the region.
Lam had a strong 2022, but is headed into a challenging 2023, as equipment spending is set to plunge in the March quarter due to an inventory correction, particularly in the NAND and DRAM memory segments, to which it is highly exposed. Trade restrictions with China are also an overhang. The rest of the year is likely to be relatively flat and the longer-term outlook is of course excellent. Semiconductor content increases in existing devices and increased application in several markets, rising device complexity and larger die sizes remain long-term positives.
This stock has lost 18.3% of its value over the past year. The Zacks Consensus Estimate for 2023 (ending June) earnings is down 1.1% in the last 60 days. The estimate for 2024 is up 2.3%.
Price and Consensus: LRCX
Image Source: Zacks Investment Research