Semiconductor WFE Stock Outlook: Time To Jump In

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.

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

Gartner is forecasting a 3.6% decline in 2020 following the 8.0% decline in 2019, despite strong spending by foundries and Intel (NASDAQ:INTC). Growth is expected to resume in 2021.

SEMI expects the 10.5% decline in 2019 to reverse into a 5.5% gain in 2020, as leading device manufactures invest in sub-10nm equipment, especially for foundry and advanced logic with memory playing a lesser role. New projects in China are also expected to be a major driver. Growth will accelerate in 2021.

While Korea is curtailing investment, Taiwan and China are accelerating, which along with North America, will account for most of the growth in 2020 and 2021.

With smartphone demand moderating and IoT demand accelerating, both these segments are likely to remain the most important drivers of semiconductor demand along with artificial intelligence, HPC and automotive. Communications infrastructure (5G) will jump on the bandwagon soon.

The three main themes for the industry are:

• Memory typically makes up the largest part of WFE spending, so oversupply and softer pricing impacted sales in 2019. The situation is expected to change this year, driven by 5G, AI, deep learning and VR, according to IC Insights The firm predicts 19% growth in NAND, particularly SSDs and 12% growth in DRAM. Accidents like the recent power outage at Samsung (KS:005930) can limit supply, thus raising prices. DigiTimes expects NAND price increases of 40%.

• China is playing a larger 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. However, since there is a certain opacity to the way China functions, this adds to uncertainty.

• 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.

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Zacks Industry Rank Indicates Improving 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 #4, which places it in the top 2% 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 challenges going forward.

The industry’s positioning in the top 2% of the Zacks-ranked industries is a result of improvement in the earnings outlook of constituent companies in aggregate. The industry’s aggregate earnings estimate revisions for 2021 are up 16.7% in the past year, indicating improving growth potential.

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

The Zacks Semiconductor-Wafer fab Equipment Industry has outperformed both the broader Zacks Computer And Technology Sector as well as the S&P 500 index over the past year.

So we see that the stocks in this industry have collectively gained 69.5% over the past year, while the Zacks S&P 500 Composite and Zacks Computer and Technology Sector gained 23.4% and 33.5%, respectively.

While the industry is small, players like Applied Materials (NASDAQ:AMAT) (AMAT), Lam Research and ASML Holding (AS:ASML) NV (ASML) are very important players.

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 22.4X compared to the S&P 500’s 18.8X. It is also slightly behind the sector’s forward-12-month P/E of 22.7X.

Over the past year, the industry has traded as high as 22.5X, as low as 15.7X and at the median of 19.0X, as the chart below shows.

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

Bottom Line

As evident, the market has started to take a turn toward the better, as in all cyclical industries that enter periods of relative strength from periods of relative weakness. But there are secular drivers of semiconductor demand that are positive for the wafer fab equipment makers that should make for a strong recovery.

Here are a couple of stocks worth buying-

Lam Research (LRCX): The stock has gained 81.5% over the past year. The Zacks Consensus Estimates for 2020 and 2021 EPS (year ending June) are up 23 cents and 9 cents, respectively in the last 60 days.

Price and Consensus: LRCX