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Semiconductor WFE Still Going Strong: 3 Picks

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The primary drivers of wafer fab equipment demand are the underlying strength of semiconductor demand and the existing capacity level.

As social distancing drove the whole world to working, studying, playing, exercising, entertaining and connecting on digital channels, there was huge demand for chips to facilitate the digitization. It now appears that this digitization has become a broader trend as companies prioritize their technology investments. Plus there are new developments in auto, clean energy, IoT and defense that should lead to robust demand for semiconductors, thus driving equipment spending.  

Another factor driving the market is China’s determination to be self-reliant in chips. This was the strongest driver of the equipment market in 2020 and should remain an important driver until the country can make the equipment locally (not expected to happen in the next 5-6 years). So demand from China will remain strong unless there are regulatory roadblocks from the American side.

Stocks like Applied Materials (AMAT - Free Report) , ASML Holding N.V. (ASML - Free Report) and Lam Research (LRCX - Free Report) look attractive at the moment.

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 (there’s a chip shortage), artificial intelligence, HPC, communications infrastructure (5G is a big driver).

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

Accordingly, Gartner is forecasting a 7.8% increase in WFE spending in 2021 (previous expectation was 3.8% growth), on top of a 13.9% increase in 2020 (previous expectation was for a 4.5% growth). The heavy spending on leading edge logic at foundries will taper off this year, which will be made up by major memory producers increasing spending to add capacity.

SEMI expects4.4% WFE spending growth in 2021 (previous 10.8%) and 5.8% growth the following year on top of 16.0% growth in 2020 (previous expectation was 6% growth). The number includes wafer processing, fab facilities, and mask/reticle equipment, which will grow 4% in 2021 and 6% in 2022 on top of the 15% growth in 2020; foundry and logic equipment (accounting for about half of total WFE sales), which will build on the mid-teens percentage growth in 2020; memory, within which NAND strength continuing from 30% growth in 2020 and DRAM taking the lead in 2021; assembly and packaging, which will grow 8% and 6%, respectively in 2021 and 2022, on top of the 20% growth in 2020; and test equipment that’s expected to grow 20% in 2020 with 5G and high-performance computing (HPC)  generating sustained momentum in 2021 and 2022.

While China, Taiwan and Korea are all expected to be strong in 2020, China’s foundry and memory capacity builds make it the leader. Korea will lead in 2021 and 2022 although Taiwan’s spending in both years will be robust.

While the industry is small, players like Applied Materials, Lam Research and ASML Holding NV are very important players. 

 

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 in agreement about the positive overall impact on WFE. This is not only because of the surge in semiconductor demand, which has a direct impact on the WFE industry, but also the fact that manufacturing operations in general have suffered less than services during this crisis.

 

  • Semiconductor demand is the primary driver of equipment purchases, although new fabs also play a big role. SEMI stated earlier that 369 fabs were in equipping mode, of which 32 new fabs are thought to have completed in 2020, with 15 slated for this year. 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 its ramping up this year is a positive.

 

  • 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. The country is investing heavily in equipment and chips in anticipation of future difficulties from an American standoff.

 

  • 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 #17, which places it in the top 7% 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 7% of Zacks-ranked industries is a result of the strength in the earnings outlook of constituent companies in aggregate. So the industry’s aggregate earnings estimate revision for 2021 represents an 11.3% increase from Feb 2020, while the 2022 revision amounts to a 28.9% increase.

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

The past year has been a good one for the Zacks Semiconductor-Wafer fab Equipment Industry. Although it was trading slightly below the S&P 500 in March, it has not looked back since. And in November it also pulled ahead of the broader sector.

So we see that the stocks in this industry have collectively gained 79.3% over the past year, while the Zacks S&P 500 Composite and Zacks Computer and Technology Sector gained 18.1% and 40.5%, respectively.

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 31.15X, which is above the S&P 500’s 22.90X and below the sector’s forward-12-month P/E of 28.81X.

Over the past year, the industry has traded as high as 31.15X, as low as 18.64X and at the median of 23.16X, as the chart below shows.

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

 

3 Stocks To Ride The Boom

With pandemic concerns waning, it’s understood that the huge boost to sales from the operating from home economy will not repeat in 2021. But semiconductor demand will remain robust because of expanding usage across sectors and countries. The strength is not a temporary phenomenon but more likely be sustained in the foreseeable future, with new fabs and capacity being added at an accelerated pace. Moreover, equipment demand is relatively more stable than the chips themselves, because semiconductor manufacturing equipment is high-value and so, a part of the long-term planning process. This is a great time to dive into semi equipment stocks. So here are a few that are worth considering-

Applied Materials (AMAT - 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 2021 and 2022 earnings are up a respective 2.4% and 2.5% in the last 30 days.

The shares have appreciated 68.3% 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, including in the red-hot China market.

Price and Consensus: AMAT

ASML Holding N.V. (ASML - Free Report) : ASML is a leading supplier of semiconductor manufacturing equipment including lithography systems (extreme ultraviolet and deep ultraviolet systems for manufacturing at advanced and other nodes), metrology and inspection systems (eg. YieldStar optical metrology solutions to measure the quality of patterns on wafers and HMI e-beam solutions to locate and analyze individual chip defects) as well as other related solutions for memory and logic chipmakers.

This Zacks Rank #2 company has gained 83.6% over the past year. The Zacks Consensus Estimates for the 2021 and 2022 EPS continue their upward trajectory, rising a respective 10.2% and 4.0% in the last 30 days.

The buildout of digital infrastructure has proved particularly beneficial for ASML in 2020 and this strength is expected to continue in 2021 as the strength in logic is accompanied by the recovery in memory. Strength in the consumer, automotive and industrial markets are particularly relevant for the company.   

Price and Consensus: ASML

Lam Research Corporation (LRCX - Free Report) : Lam Research supplies wafer fabrication equipment for deposition, etching, cleaning and metrology, as well as related services that are used by semiconductor manufacturers in the front-end of the semiconductor manufacturing process.  The company has significant exposure to the memory segment (approximately two-thirds of its business), followed by foundry and then logic.

That’s why the company is expected to grow very strongly in the current fiscal year that’s expected to reflect both the ongoing strength in logic and foundry as well as the recovery in memory. As memory rebounds further, the strength should be ongoing.

This Zacks Rank #2 company has gained 73.1% over the past year. The Zacks Consensus Estimates for the 2021 and 2022 EPS are up a respective 10.7% and 6.7% in the last 30 days.

Price and Consensus: LRCX

 

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