The primary drivers of wafer fab equipment demand are the underlying strength of semiconductor demand and the existing capacity level.
 
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 will ensure continued strength in semiconductor demand, thus driving equipment spending. 
 
China’s determination to be self-reliant in chips is currently a big driver of equipment sales. But increasing pressure from the West to contain its progress, has the country racing to make its own. In the interim, and barring regulatory roadblocks from the American side, this remains a tailwind for the industry.
 
Other countries deciding to onshore production as a strategic necessity is a long-term positive.
 
Market researchers also see continued strength. The most recent estimate from Gartner has WFE revenue growth at 35.8% in 2021 and 10.7% in 2022. There are three drivers: continued spending on leading edge logic by IDMs and foundries and capacity increases at memory producers. Trailing edge investment to alleviate supply chain constraints is not a driver going forward. Gartner expects WFE spending to come down in 2023 and 2024 as purchased equipment is digested. SEMI sees 10% growth in 2022 on top of the 39% growth in 2021 with 46% of 2022 spending coming from foundry, 37% from memory (as DRAM declines and 3D NAND nudges higher) and the rest from logic equipment. Microcontrollers (+47%) and power devices (+33%) are expected to be the strongest categories this year. Korea (+14%), Taiwan (+14%) and China (-20%) remain the biggest spenders, together accounting for 73% of WFE spending.  EMEA and Japan are expected to grow a respective 145% and 29%.
 
Despite the growth prospects, macro and geopolitical considerations are weighing down stocks like Applied Materials (AMAT Quick QuoteAMAT - Free Report) , Lam Research (LRCX Quick QuoteLRCX - Free Report) and Applied Materials (AMAT Quick QuoteAMAT - Free Report) .

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.

Fabrication equipment demand is dependent on the level of semiconductor demand and the level of installed capacity.

Semiconductor demand primarily comes from cloud, ecommerce and PCs (COVID-related acceleration), smartphones (moderating demand), IoT (strong demand), automotive and industrial (chip shortage), artifici

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. One lasting impact of the pandemic is the approach to inventory building. Customers are now leaning toward a more cautious (and expensive) just-in-case approach rather than the cheaper but riskier just-in-time approach.

 

• The war in Ukraine 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. Even for those that don’t directly source a lot of their requirement from these countries, the general scarcity of supply is increasing prices of the commodity, which can result in weaker margins.

 

• 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 (as both consumer and manufacturer of chips) 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 these will have to be imported.

 

• 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 (7nm and below), memory chip advancements (3D NAND processes are maturing, driving down cost, increasing layers are adding complexity), denser packaging (MEMS) and so forth. 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; new 3D structures like gate-all-around transistors, backside power distribution, next-generation 3D NAND and 3D DRAM; new materials in gate, contact and interconnect; new ways to shrink from EUV lithography to advanced patterning; and advanced packaging from 2.5D silicon interposers to 3D chiplets and hybrid bonding. The increased complexities of building modern chips is good for equipment makers.

Zacks Industry Rank Indicates 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 #115, which places it in the top 46% 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 relative stability going forward.

The industry’s positioning in the top 50% of Zacks-ranked industries is a result of the strength in the earnings outlook of constituent companies in aggregate. The industry’s aggregate earnings estimate revision for 2022 represents a 26.9% increase from Mar 2021, while the 2023 revision amounts to a 30% 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 Zacks Semiconductor-Wafer fab Equipment Industry has outperformed both the broader technology sector and the S&P 500 through most of the past year. But as a reaction to investor concerns around growth names and the tech sector in particular, it has softened this year. 

So we see that the stocks in this industry have collectively gained 4.2% over the past year, while the S&P 500 Composite gained 6.1% and the Zacks Computer and Technology Sector lost 4.3%.

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 19.98X (the lowest multiple over the past year). This is just above the S&P 500’s 18.56X and below the sector’s forward-12-month P/E of 22.29X.

Over the past year, the industry has traded as high as 31.11X, as low as 19.98X and at the median of 27.73X, as the chart below shows.

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

Image Source: Zacks Investment Research

2 Stocks With Room To Run

With pandemic concerns waning, it’s understood that the huge boost to 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. Particularly because it will play out gradually across the world, leading to sustained strength in demand.

Semiconductor demand will also be boosted by their expanding application across sectors and countries and current demand reflects this. Equipment demand is also 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. Additionally, with so much capacity added in 2021 and 2022, it remains to be seen what the demand scenario looks like in the next few years.

The industry has however been beaten down over the last few months and is certainly worth more than its current value reflects, which could be a reason for considering these #3 (Hold) ranked stocks.

Applied Materials (AMAT Quick QuoteAMAT - Free Report) : This 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.

Management has said that Applied Materials is seeing very strong order growth and is close to being ‘sold out for the year’ and that the outlook for 2023 is also very strong. It has also been transferring its parts and service revenue to the subscription model, locking in customers for the longer term.

The Zacks Consensus Estimate for 2022 (ending October) is down 8 cents in the last 30 days while the 2023 estimate is up 47 cents, which could be increased conservatism stemming from the geopolitical crisis or a sign that some order/s got pushed out.

The shares are up 7.6% 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

Image Source: Zacks Investment Research

Lam Research Corporation (LRCX Quick QuoteLRCX - 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.

SEMI expects 37% growth in 2022 with DRAM declining but 3D NAND moving higher. Management expects WFE spending of around $100 billion this year. Foundry/logic remains the strongest product segment for Lam.

The company has been adding capacity in the U.S., Korea, Taiwan and Malaysia to cater to demand that remains extremely strong. But a string of problems including COVID-19, labor shortages, freight and logistics, cost escalation, and supply chain constraints are increasing cost.

This stock has lost 9.9% of its value over the past year. The Zacks Consensus Estimates for 2022 earnings is down $1.63 (4.8%) in the last 60 days. The estimate for 2023 is up $1.27 (3.4%).

Price and Consensus: LRCX

Image Source: Zacks Investment Research