Despite the solid growth trajectory that we expect for the wafer fab equipment (WFE) industry, we are recommending that investors wait for a suitably entry point for Applied Materials (AMAT Quick QuoteAMAT - Free Report) , Lam Research (LRCX Quick QuoteLRCX - Free Report) and ASML Holding N.V. (ASML Quick QuoteASML - Free Report) . The shares continue to trade up strongly although the industry-wide valuation looks reasonable. Supply side challenges stemming from increasingly turbulent geopolitics are also a concern.
 
The primary drivers of WFE demand are the strength of semiconductor demand and the existing capacity level.
 
As far as the demand for semiconductors is concerned, it will be hugely boosted by ongoing transitions adopting AI, IoT, EVs and renewable energy. Government regulations and funding around the world will support this trend. The future of warfare is also in the most advanced electronics. Therefore, strategic necessity will continue to boost demand and production around the world, particularly in China, the U.S. and Europe.

These factors will drive capacity build right through this decade. While there are constraints on selling leading edge semiconductors and equipment to China, the country is generating stronger-than-expected demand at the trailing edge, indicating significant capacity adds. Because of these reasons, things like the possibility of a recession and interest rates are likely to have a limited effect on demand in the foreseeable future.   
 
If softness in consumer and computing hit semiconductor demand in 2023, it is AI-driven workloads, particularly generative AI and LLM that will increase demand for servers and consequently, semiconductors (mainly GPUs and NPUs) this year. According to SEMI’s Mid-Year Total Semiconductor Equipment Forecast, the equipment industry will grow 3.4% this year, setting a new record, driven by capacity expansion, new fab projects and high demand for advanced technologies and solutions across front-end and back-end operations.

Sales will strengthen by 17% the following year. NAND equipment sales are set to grow 1.5% in 2024 and 55.5% in 2025. DRAM equipment sales are expected to grow 24.1% this year and 12.3% next year. China, Taiwan and Korea are expected to remain the top destinations for WFE through 2025, with China remaining the top spender (a record $35 billion in 2024, followed by a contraction in 2025).
 
Utilization rates are picking up now, which helps spares and services business at equipment makers. New tools are the result of continued innovation to facilitate the multiple technology transitions going on as we speak, and also to lower their cost of ownership.

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 Shaping the Industry

• Technology transitions, such as the move toward larger wafer sizes (High-bandwidth memory or HBM, fab upgrades to 300mm, plus 200mm demand), shrinking nodes (pushing to 3nm 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 accounts for most of the demand and Samsung (with its latest generation HBM 3e) is being snapped up by Chinese players. 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 and will remain very strong on the back of a huge innovation cycle in AI, IoT, EV and renewable energy that will transform every aspect of the economy. The market is expected to enter an upcycle next year, which will also drive equipment demand. Additionally, new fabs are likely to play a significant role in the next few of years. China in particular is investing heavily in capacity, and next year, lagging edge facilities will ramp up in the US to take advantage of the CHIPS Act. Other countries are also expected to build capacity for strategic reasons. With many new fabs expected to come online over the next decade, WFE demand is expected to remain very strong in the foreseeable future. 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 and the next, reflecting positively on the near-term outlook. Over the next decade, the integration of memory with compute could stabilize demand to a certain extent.

 

• Export regulations and international equations remain one of the most important factors 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. Since semi equipment makers generate substantial business from Chinese players, so the separation will be painful. Applied Materials has said that trade rules restricted it from more than 10% of the China market in 2023. 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.

 

• Still-high interest rates would normally be a deterrent to capex investments. This rule is not expected to hold true in the case of WFE. For one thing, semiconductor demand is too strong at the moment and existing capacity just not enough. And second, 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, now more so than ever given the increasing complexities of chip design and increased focus on reducing the cost of ownership. Therefore, 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.

Zacks Industry Rank Reflects Strong Growth 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 #16, which places it in the top 6% 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 are conducive to growth right now.

This is also reflected in the direction of analyst estimate revisions, which have trended upward from the beginning of 2024. Overall, the industry’s aggregate earnings estimate revision for 2024 shows a more or less steady increase of 4.6% over the past year. The 2025 revision represents a 14.8% increase from 2024, picking up strongly from February.

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

As has been a normal trend for the last several years, the industry continued to lead the Zacks Semiconductor-Wafer fab Equipment industry and S&P 500’s performance over the past year. This may be attributed to the long-term demand outlook for the industry, which trumps the uncertainty inherent in many others as the broader economy remains sluggish. The relative stability that comes from the long sales cycles and contracts could be another reason for investor sentiments. 

Net-net, the stocks in this industry have collectively gained 41.2% over the past year, while the Zacks Computer and Technology Sector gained 39.5% and the S&P 500 Composite 33.9%.

One-Year Price Performance

Image Source: Zacks Investment Research

Industry's Valuation Reasonable

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’s valuation is reasonable. It is currently trading at a 24.30X multiple, which while being a 12.7% premium to the S&P 500’s 21.57X, is below the sector’s 25.87X as well as its own median level of 29.45X over the past year. Tech stocks typically trade at a premium to the S&P 500 because of their superior growth potential.

Over the past year, the industry has traded in the range of 22.68X to 33.53X as the chart below shows.

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

Image Source: Zacks Investment Research

Stocks with Solid Growth Outlook

The strongest driver for the semiconductor and allied industries is the ongoing adoption of artificial intelligence, as well as things like IoT, automation/robotics, EVs and renewable energy, each with multiple legs of growth. Equipment demand is more stable than chips, because semiconductor manufacturing equipment is high-value and so, is developed with significant customer collaboration.

Moreover, there are only a few large players, each offering their own highly specialized technology, essential for the entire semiconductor fabrication process. Therefore, semi equipment purchase is a part of their clients’ long-term planning process. That said, geopolitical tensions could increase demand but could also disrupt the supply chain, thereby increasing cost and hurting profitability.

Here are three of #3 (Neutral) rated stocks that are worth keeping an eye on:

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.

Third, it was an early investor in materials technology, which should help it gain leverage as manufacturing gets more complex, especially at the smaller nodes.

Fourth, its strategy of selling integrated solutions increases dollar content per product (integrated solutions have grown from a 20% revenue share in 2019 share to 30% today).

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 6X 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 company is optimistic about continued share gains in all its served markets.

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. The high renewal rates of over 90% lend stability and visibility to revenues. Increasing fab utilization this year is driving demand in this segment.

The Zacks Consensus Estimate for 2024 (ending October) has increased 16 cents 1.9%) in the last 60 days. The Zacks Consensus Estimate for 2025 has increased 23 cents (2.4%) during the same period. Analysts currently expect revenue and earnings in 2024 to grow a respective 2.1% and 5.5%. In 2025, they’re expected to grow a respective 10.9% and 13.4%.

Shares of the company have appreciated 46.5% over the past year.

Price and Consensus: AMAT

Image Source: Zacks Investment Research

 

ASML Holding N.V. (ASML Quick QuoteASML - Free Report)

Veldhoven, the Netherlands-based ASML is the leading producer of advanced lithography tools used at the front-end of the semiconductor manufacturing process. Its differentiated technology makes ASML a key supplier into the semiconductor manufacturing process, which lends tremendous stability and visibility to its revenue stream.

Like the other two major equipment makers, ASML too expects momentum in the business to continue, driven by AI, electrification and energy transition among other things. As the semiconductor market continues to expand and the technology nodes continue to shrink, the demand for its products continues to increase.

The company has orders from a number of new fabs being constructed across the world and management is also expecting a cyclical upturn in 2025, driven by all segments of the market. Additionally, ASML has several advanced tools in the pipeline for both memory and logic advanced nodes that improve upon the cost of ownership, generating higher ASPs and stronger margins for the company.

The DRAM business is currently being fueled by technology node transitions in support of advanced memories such as DDR5 and HBM. The expected slowdown in logic is mainly on account of customers digesting heavy investments in 2023. Based on a solid order book, management expects a strong 2025.

The Zacks Consensus Estimate for 2024 has increased 8 cents (less than a percentage point) while the 2025 estimate increased 67 cents (2%) in the last 60 days. Analysts have significantly raised their estimates for this stock. They currently expect revenue growth of 1.24% in 2024 and 35.2% in 2025. EPS Expectations have also improved: down 5.3% this year and up 63.1% in the next.

The shares are up 41.8% over the past year.

Price and Consensus: ASML

Image Source: Zacks Investment Research

 

Lam Research Corp. (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 diversification strategy has better positioned it to tap the technology inflection-driven potential in these segments of the market.

The next few years will see tremendous leaps in WFE spending for advanced compute, memory and storage. Storage in particular is at the very early stages, as 80% of enterprise data is still stored on HDDs. The improvements in NAND capability and cost makes it extremely likely that its faster read-write capabilities will find many more takers.

Currently, its DRAM business is being driven by WFE spending on HBM, and stronger-than-expected demand from domestic China. On the NAND side, demand is expected to remain strong through the rest of the year and in 2025, driven by generative AI and other technologies. Foundry logic is being driven by China, which is running stronger than expected although sales are expected to drop off in the second half. Higher utilization is driving spares revenue.

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 2023 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 (for example, in Korea, Taiwan and the US) to facilitate collaboration and reduce the time to solutions. It is also using its proprietary digital modeling technique called Semiverse Solutions that will reduce the time and cost of technology development.

In the last 60 days, there is no change in the Zacks Consensus Estimate for 2025 (ending June) although the estimate for 2026 is up around 3 cents. Analysts currently expect revenue to grow a respective16.1% and 17.1% in 2024 and 2025 with corresponding earnings declining 88.2% and increasing 26.4%. The high exposure to the memory segment makes Lam results cyclical.

LRCX shares have appreciated 30.2% over the past year.

Price Performance: LRCX

Image Source: Zacks Investment Research