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, interest rates that have an effect on consumer spending, or the diversion of consumer funds to leisure and/or travel activity affect one or both of the primary factors. Technology transitions constitute an additional driver for the industry because they require fresh equipment for fabrication and/or packaging.   
 
Gartner is optimistic about a solid recovery in semiconductor demand in 2024 with growth across all chip types led by memory. Because of the inventory glut in memory chips last year, there was a sharp pullback in the category with prices hitting rock bottom. In 2024, there will be a total reversal, with NAND revenue increasing 49.6% and DRAM increasing 88% for a combined growth of 66.3% in memory.

If softness in consumer and computing hit semiconductor demand in 2023, it is from AI-driven workloads, particularly generative AI and LLM that will increase demand for servers and consequently, semiconductors (mainly GPUs and workload accelerators) this year. By 2027, Gartner expects that the integration of AI techniques into data center applications will result in a more than 20% increase in servers. The strength of semiconductor demand is positive for equipment sales although capacity not so much. 
 
This will bring about a 4% decline in WFE revenue this year, on top of a 10% decline in 2023, according to Gartner. Growth is expected to return thereafter with a 10% increase in 2025 and continuing through 2027.
 
As utilization rates pick up beginning in the first quarter of 2024, semiconductor capex is likely to follow suit. According to SEMI, capex spending will accelerate this year despite the softening in auto and industrial markets that is keeping analog makers under pressure. The firm expects 2024 to be a transition year followed by a strong rebound in 2025, driven by capacity expansion, new fab projects and high demand for advanced technologies and solutions across front-end and back-end operations.
 
Overall, WFE sales are projected to increase 3% in 2024 and 18% in 2025; test equipment a respective 13.9% and 17%; and assembly and packaging 24.3% and 20%. On the memory side, NAND equipment is expected to grow 21% in 2024 and 51% in 2025, with DRAM growing 3% in 2024 and 20% in 2025. While China, Taiwan and Korea are expected to remain the top destinations for WFE through 2025, China growth will be affected by tough comps with 2023.
 
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 AI, 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 could continue to weigh on stocks like Applied Materials (AMAT Quick QuoteAMAT - Free Report) and Lam Research (LRCX Quick QuoteLRCX - Free Report) .

About the Industry

This industry includes suppliers of manufacturing equipment, services and software for semiconductor wafer fabrication. Wafer fabrication involves the treatment of a silicon wafer 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 accelerating), ecommerce (growth is steady), PCs (turning the corner), smartphones (also turning the corner), IoT, AI, HPC (strong), automotive and industrial (slower) and communications infrastructure (5G-driven).

Factors Driving the Industry

• Export regulations remain one of the biggest concerns right now. The increasing polarization between the two largest economies makes this a longer-term concern. Samsung, SK Hynix and TSMC have approvals, but Gartner expects their China expansion plans to be conservative. NVIDIA was also banned from supplying its A800 and H800 chips to China, although they had specifically developed the chips for the market. Additionally, semi equipment makers generate substantial business from Chinese players, so the separation will be painful. It remains to be seen when fabs coming up at other locations can offset the business lost in China. The fab construction subsidies in the CHIPS Act are bringing additional capacity to the U.S. and the European Chips Act to Europe. At the same time, countries like China, India, Japan, South Korea and Taiwan are also aggressively wooing chipmakers to set up fabs. The onset of the AI revolution has everyone thinking that demand will accelerate manifold while strategic interests make such investments imperative. So there is the possibility that such extensive builds will lead to excess capacity, which only depresses prices, hurts profits and pushes out the payback period.

 

• Technology transitions, such as the move toward larger wafer sizes (High-bandwidth memory or HBM, fab upgrades to 300mm, plus 200mm demand), shrinking nodes (7nm and below), memory chip advancements (increasing layers and stacking are adding complexity), denser packaging (MEMS), etc. are positive for equipment purchases, since each transition requires advanced equipment for manufacturing. HBM in particular is expected to be a major driver this year, because it enables a 30% improvement in energy efficiency. TrendForce estimates that its share of DRAM revenue will grow from 8.4% in 2023 to 20.1% by the end of 2024: “HBM die size is generally 35 to 45 percent larger than DDR5 memory of the same capacity. The yield rate (including through silicon via) is approximately 20 to 30 percent lower than DDR5 and the production cycle (including TSV) is 1.5 to 2 months longer than DDR5. ”Therefore, volume production will mean much more equipment demand than DDR5. SK Hynix owns most of the market and Samsung is expected to take share this year. With all the major chipmakers (NVIDIA, Intel and AMD) slated to refresh their CPU and/or GPU lines this year, and other players also looking to exploit the AI opportunity, capex should maintain its growth trajectory in the foreseeable future. Materials research, device complexities, the need for greater manufacturing integration and new applications are also important drivers. Other inflections will continue to come from advancement in front and back-end processes and from new chip architectures.

 

• 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 where cyclicality is the most evident. That said, the memory market is poised to soar this year, reflecting positively on the near-term outlook. Over the next decade, the integration of memory with compute could stabilize demand to that extent.

 

• With interest rates stabilizing and likely to go down this year, companies would be encouraged to increase their spending on capital equipment, although a slowdown in the economy this year, a response to successive rate hikes last year, could to a certain extent weigh on the industry. However, most of the large equipment makers that account for the bulk of industry revenues work closely with their clients through the development and marketing phases, and sales are usually confirmed before the products actually hit the market. Also, equipment purchases are generally long-term strategic decisions, so demand tends to be relatively stable.

 

• Geopolitical tensions continue to simmer all over the world. There is the Ukraine war that seems to be dragging on forever and it has been joined by the war in Gaza. China’s increasing possessiveness about Taiwan is another concern particularly because of the amount of leading-edge semiconductor production that happens in the country. This kind of upheaval is not conducive to economic growth that can spur semiconductor demand.

Zacks Industry Rank Reflects Relative Strength

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 #96, which places it in the top 38% of 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, indicates that market conditions, although improving, are not yet supportive of growth.

The industry’s aggregate earnings estimate revision for 2024 is essentially consistent with Mar 2023 although they have moved around quite a bit in the middle (Aug 2023 peak, Dec 2023 trough). The 2025 revision represents a 6% increase from 2024, following roughly the same route.

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 Leads on Shareholder Returns

Looking at the Zacks Semiconductor-Wafer fab Equipment industry’s performance over the past year, it appears that there was some negative sentiment between August and October of last year, but sentiments turned thereafter as the industry soared to reach and then exceed both the broader sector and the S&P 500. This may be attributed to the current dynamics boosting demand in the industry, particularly at a time when other industries may be experiencing some softness related to uncertainty in the broader economy. Its long-term prospects and the relative stability that comes from the long sales cycles and contracts are other positives. 

Net-net, the stocks in this industry have collectively gained 56.7% over the past year, while the Zacks Computer and Technology Sector gained 41.5% and the S&P 500 Composite 27.6%.

One-Year Price Performance

Image Source: Zacks Investment Research

Valuation Is Rich

On the basis of the forward 12-month price-to-earnings (P/E) ratio, a commonly used method of valuing semiconductor equipment stocks, we see that the industry is overvalued. It is currently trading at a 33.43X multiple, which is close to its highest point over the past year. The industry is also trading at an 25.6% premium to the sector’s 26.61X and a 56% premium to the S&P 500’s 21.43X.

Over the past year, the industry has traded as high as 33.63X, as low as 21.99X and at a median of 26.41X, as the chart below shows.

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

Image Source: Zacks Investment Research

2 Stocks with Improving 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.

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 that disrupt the supply chain and increase cost, and therefore profitability could continue or even worsen.

Here are a couple of stocks looking good right now:

Applied Materials, Inc. (AMAT Quick QuoteAMAT - Free Report)

Applied Materials offers manufacturing equipment, services and software to the semiconductor, display, and related industries. Its long-term strategy positions it for continued strength in performance.

First, the company has deep customer relationships, which allows it to foresee inflections in the market that are so important for equipment makers to capitalize on. Therefore, it is one of the most important players catering to new and important trends in AI, IoT, EVs, renewable energy and the like. The close ties with customers and partners also help it develop product designs in close and early collaboration with customers, reducing the time to market and ensuring a strong uptake.

Second, the company has a huge breadth of products and capabilities, which along with its close relationships allow it to combine, co-optimize and integrate its technologies to develop customized solutions.

As a result, the company is strongly positioned to expand its total available market as HBM takes off this year. Management expects its HBM business to grow at a CAGR of 50% (it made up 5% of DRAM output in 2023) over the next few years with 2024 revenues growing 4X over 2023. Another important inflection point, the shift from FinFET to gate-all-around grows Applied’s available market by $1 billion for every 100,000 wafer starts per month of capacity. Management expects that its share gains in this market will allow it to capture over 50% of the spending for the process equipment used in this new transistor module.

The services business (AGS) is tied to the equipment business, and over time, a significant portion has become subscriptions-based. Currently, almost 17,000 tools are under service agreements, up 8% year-on-year. The high renewal rates of over 90% lend stability and visibility to revenues.

2024 is shaping up well for the company, with leading-edge foundry-logic growing year-over-year, despite some important projects getting delayed. On the memory side, both NAND and DRAM expected to grow this year.

The Zacks Consensus Estimate for 2024 (ending October) has increased 4 cents (0.5%) in the last 30 days. The Zacks Consensus Estimate for 2025 has dropped 8 cents (0.9%) during the same period. Analysts currently expect revenue and earnings in 2024 to be more or less consistent with the prior year. In 2025, they’re expected to grow a respective 10% and 15.5%.

Shares of this Zacks Rank #2 (Buy) rated company have appreciated 68.6% over the past year.

 

Lam Research Corporation (LRCX Quick QuoteLRCX - Free Report)

Lam Research designs, manufactures, markets, refurbishes and services semiconductor processing equipment used in the fabrication of integrated circuits.

Lam has been diversifying its focus to foundry, logic and specialty technology segments by stepping up investments in innovation and new products. This year, foundry logic spending is expected to be mainly on the leading-edge side, unlike the prior year, when it was mainly Chinese spending on the lagging edge (where Lam doesn’t play).

As a result of its diversification strategy, Lam has become better positioned to tap the technology inflection-driven potential in these segments of the market. On the memory side, both DRAM and NAND are expected to grow this year. HBM-driven capacity additions and node conversion-related spending will drive DRAM while technology upgrade-related spending will drive NAND.

Like Applied Materials, the services side of the business remains particularly strong. Management has said that the support business has grown 80% from 2019 levels, helping it to manage costs and efficiency, driving operating margin improvement (from prior troughs).

Management expects semiconductor industry revenues to reach a trillion dollars by the end of the decade, involving considerable increases in manufacturing complexity. They believe that this will double WFE spending from today's levels. Lam's served markets of etch and deposition are expected to outpace growth in overall WFE and management has strategic initiatives in place to tap this potential. The company is building its facilities close to its customers’ R&D labs to facilitate collaboration and reduce the time to solutions.

The Zacks Consensus Estimate for 2024 (ending June) has increased 12 cents (0.4%) from 60 days ago. The Zacks Consensus Estimate for 2025 has increased 16 cents (0.5%) during the same period. Both revenue and earnings are expected to decline over 15% this year (because of the slump in the memory market to which Lam has considerable exposure). In 2025 however, they are expected to grow 14.7% and 19.9%, respectively.

The shares of this Zacks Rank #2 company have increased 86.3% over the past year.

Price and Consensus: LRCX

Image Source: Zacks Investment Research