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The primary drivers of wafer fab equipment demand are the strength of semiconductor demand and the existing capacity level. Other factors, such as the recently-imposed constraints on selling semiconductors to China, inflationary pressures that impact consumer spending, or the impending recession, affect one or both of the primary factors.
Estimates from Gartner on global semiconductor demand have taken a sudden turn for the worse, reflecting these concerns. The research firm now expects 7.4% revenue growth, which is down from 13.6% estimated in the previous quarter. It also expects revenue to decline 2.5% in 2023 due to macroeconomic factors.
However, it’s important to note that capital equipment spending is usually long-term and customers place their orders well in advance. Therefore, because of the length of equipment sales cycles, short-term concerns usually don’t hurt the outlook immediately. In this case, if we have a short recession, chances are that equipment demand will pick up before it drops off. If this doesn’t happen, capacity added this year could become a burden next year. Gartner expects 2022 semi equipment spending to increase 18% with related service revenue growing 24%.
SEMI sees 8% growth in 2022 on top of the 7% growth in 2021. Foundry is expected to remain the biggest segment in 2022 with a 53% share followed by memory, which is expected to account for 33% as 158 existing fabs increase capacity, accounting for 85% of total equipment spend.
Spending will increase 6% in 2023, with foundry remaining by far the largest segment with 53% share followed by memory with 34%. There will be capacity increases at 129 existing fabs (83% of total spending). Taiwan, the biggest spender, is expected to increase investment by 52% in 2022, followed by Korea, which will increase by 7% and then China, which will reduce by 14%.
Record investments are expected in Taiwan, Korea and Southeast Asia in 2023. The Americas will increase by 19% this year and 13% in the next.
Neither of these estimates account for possible cuts related to the China ban, so there is downside risk in these estimates.
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.
Despite the underlying strength, macro and geopolitical considerations, and continued input cost inflation are likely to offset the effect of easing supply chain constraints 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 (ongoing pandemic adjustments), smartphones (moderating demand), IoT (strong demand), automotive and industrial (chip shortage improving), and AI, HPC, comm infrastructure.
Factors Shaping the Industry
New export regulations are the biggest concern 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 easing supply chain issues. Rate hikes also affect other economies, leading to a global slowdown. This hurts semiconductor companies 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. There is the question of the Chinese COVID policy, which is slowing down production and trade in the region. China is also getting more possessive about Taiwan, which it would like to annex. 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.
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. The biggest positive is that WFE takes time to produce and sell. So short term issues have a limited impact.
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 few years, which will make this a major driver in 2022 and beyond. According to SEMI, 10 new fabs will break ground in 2022, of which 7 are leading edge, together generating demand for $140 billion worth of equipment over the next few years. This is in addition to the 19 in 2021, of which leading edge (300mm) number 15. It generally takes two years from ground-breaking to equipping, so the current strength in equipment demand has a long tail. It is also worth keeping in mind that equipment demand tends to be relatively stable in times of short-term challenges because they are made with a longer-term objective. Memory typically makes up the largest part of WFE spending, but of the 29 new fabs mentioned here, 15 are meant for high-volume foundry production with 30,000 to 220,000 wspm capacity and 4 relate to memory production with 100,000 to 400,000 wspm capacity.
China continues to play a big role 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. Since the west doesn’t want to sell it the most advanced equipment, it is investing heavily in its own equipment technology and there are concerns that it may have stolen some intellectual property. But because this is likely to take a few years, it’s a positive that of the 29 new fabs breaking ground in 2021 and 2022, 8 will be built in China. Because they will have to use imported equipment.
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.
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 weakness going forward.
The industry’s positioning in the bottom 50% of Zacks-ranked industries is a result of the weakening in the earnings outlook of constituent companies in aggregate. The industry’s aggregate earnings estimate revision for 2022 represents a 15.6% decline from Oct 2021, while the 2023 revision amounts to a 13.5% decline.
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 below the S&P 500 through all of 2022 and also dropped below the broader technology sector since June. Initially, it was the supply chain disruption that limited access to components and hurt sales. But in the last few months, investors have grown increasingly concerned about semiconductor demand given the drop off in computing as the market corrected itself after it overbought during the pandemic. Some of the digital transactions also moved back to stores during this time, adding to this concern. Additionally, growing concerns about a recession next year also contributed to the negativity.
So we see that the stocks in this industry have collectively lost 35.8% over the past year, while the S&P 500 Composite lost 16.9% and the Zacks Computer and Technology Sector 33.4%.
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 18.65X, below the median level over the past year and the sector’s 20.28X multiple. It is however slightly above the S&P 500’s 17.09X.
Over the past year, the industry has traded as high as 27.66X, as low as 14.92X and at the median of 20.30X, 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
ASML Holding NV (ASML - Free Report) : This is one of the world’s largest suppliers of advanced semiconductor equipment systems consisting of lithography, metrology and inspection related systems for memory and logic chipmakers.
Management has said that while demand dynamics is varying by industry, the overall demand for ASML lithography systems remains strong. Additionally, their initial assessment of new export regulations leads them to conclude that the restrictions do not amend the rules governing lithography equipment shipped by ASML out of the Netherlands. Therefore, the direct impact on ASML is currently expected to be limited.
The Zacks Consensus Estimate for 2022 is up 1.6% in the last 30 days while the 2023 estimate is down 7.1%. Geopolitical concerns are considerable for ASML, which is making analysts incrementally cautious.
The shares are down 41.4% over the past year.
Price and Consensus: ASML
Image Source: Zacks Investment Research
Lam Research Corporation (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.
Management estimates that the export regulations will result in a $2-2.5 billion hit to 2023 revenue. They expect overall WFE demand including the China impact to decline 20% with most of this concentrated in memory. They currently expect a strong comeback in memory after 2023. Expanding semiconductor content in end devices, rising device complexity and larger die sizes remain long-term positives.
This stock has lost 29.3% of its value over the past year. The Zacks Consensus Estimate for 2022 earnings is down 6.4% in the last 30 days. The estimate for 2023 is down 23.1%..
Price and Consensus: LRCX
Image Source: Zacks Investment Research
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2 Long-Term Bets on the Semi Equipment Industry
The primary drivers of wafer fab equipment demand are the strength of semiconductor demand and the existing capacity level. Other factors, such as the recently-imposed constraints on selling semiconductors to China, inflationary pressures that impact consumer spending, or the impending recession, affect one or both of the primary factors.
Estimates from Gartner on global semiconductor demand have taken a sudden turn for the worse, reflecting these concerns. The research firm now expects 7.4% revenue growth, which is down from 13.6% estimated in the previous quarter. It also expects revenue to decline 2.5% in 2023 due to macroeconomic factors.
However, it’s important to note that capital equipment spending is usually long-term and customers place their orders well in advance. Therefore, because of the length of equipment sales cycles, short-term concerns usually don’t hurt the outlook immediately. In this case, if we have a short recession, chances are that equipment demand will pick up before it drops off. If this doesn’t happen, capacity added this year could become a burden next year. Gartner expects 2022 semi equipment spending to increase 18% with related service revenue growing 24%.
SEMI sees 8% growth in 2022 on top of the 7% growth in 2021. Foundry is expected to remain the biggest segment in 2022 with a 53% share followed by memory, which is expected to account for 33% as 158 existing fabs increase capacity, accounting for 85% of total equipment spend.
Spending will increase 6% in 2023, with foundry remaining by far the largest segment with 53% share followed by memory with 34%. There will be capacity increases at 129 existing fabs (83% of total spending). Taiwan, the biggest spender, is expected to increase investment by 52% in 2022, followed by Korea, which will increase by 7% and then China, which will reduce by 14%.
Record investments are expected in Taiwan, Korea and Southeast Asia in 2023. The Americas will increase by 19% this year and 13% in the next.
Neither of these estimates account for possible cuts related to the China ban, so there is downside risk in these estimates.
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.
Despite the underlying strength, macro and geopolitical considerations, and continued input cost inflation are likely to offset the effect of easing supply chain constraints 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 (ongoing pandemic adjustments), smartphones (moderating demand), IoT (strong demand), automotive and industrial (chip shortage improving), and AI, HPC, comm infrastructure.
Factors Shaping the Industry
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Semiconductor Equipment -Wafer FabricationIndustry is a stock group within the broader Zacks Computer And TechnologySector. It carries a Zacks Industry Rank #232, which places it in the bottom 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 weakness going forward.
The industry’s positioning in the bottom 50% of Zacks-ranked industries is a result of the weakening in the earnings outlook of constituent companies in aggregate. The industry’s aggregate earnings estimate revision for 2022 represents a 15.6% decline from Oct 2021, while the 2023 revision amounts to a 13.5% decline.
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 below the S&P 500 through all of 2022 and also dropped below the broader technology sector since June. Initially, it was the supply chain disruption that limited access to components and hurt sales. But in the last few months, investors have grown increasingly concerned about semiconductor demand given the drop off in computing as the market corrected itself after it overbought during the pandemic. Some of the digital transactions also moved back to stores during this time, adding to this concern. Additionally, growing concerns about a recession next year also contributed to the negativity.
So we see that the stocks in this industry have collectively lost 35.8% over the past year, while the S&P 500 Composite lost 16.9% and the Zacks Computer and Technology Sector 33.4%.
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 18.65X, below the median level over the past year and the sector’s 20.28X multiple. It is however slightly above the S&P 500’s 17.09X.
Over the past year, the industry has traded as high as 27.66X, as low as 14.92X and at the median of 20.30X, 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
ASML Holding NV (ASML - Free Report) : This is one of the world’s largest suppliers of advanced semiconductor equipment systems consisting of lithography, metrology and inspection related systems for memory and logic chipmakers.
Management has said that while demand dynamics is varying by industry, the overall demand for ASML lithography systems remains strong. Additionally, their initial assessment of new export regulations leads them to conclude that the restrictions do not amend the rules governing lithography equipment shipped by ASML out of the Netherlands. Therefore, the direct impact on ASML is currently expected to be limited.
The Zacks Consensus Estimate for 2022 is up 1.6% in the last 30 days while the 2023 estimate is down 7.1%. Geopolitical concerns are considerable for ASML, which is making analysts incrementally cautious.
The shares are down 41.4% over the past year.
Price and Consensus: ASML
Image Source: Zacks Investment Research
Lam Research Corporation (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.
Management estimates that the export regulations will result in a $2-2.5 billion hit to 2023 revenue. They expect overall WFE demand including the China impact to decline 20% with most of this concentrated in memory. They currently expect a strong comeback in memory after 2023. Expanding semiconductor content in end devices, rising device complexity and larger die sizes remain long-term positives.
This stock has lost 29.3% of its value over the past year. The Zacks Consensus Estimate for 2022 earnings is down 6.4% in the last 30 days. The estimate for 2023 is down 23.1%..
Price and Consensus: LRCX
Image Source: Zacks Investment Research