Semiconductor WFE Stock Outlook: Avoiding Is A Good Idea

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 the demand for semiconductors themselves on the one hand and the level of installed capacity on the other.

Researchers are divided on the wafer fab equipment spending environment.

Gartner is forecasting declines in both 2019 and 2020, attributed to weak business conditions and inventory glut at customers.

SEMI expects the 19% decline in 2019 to be more than made up by a 20% rebound next year, mainly because of gyrations in the memory segment, which will decline 45% this year and grow 45% in the next. If the forecast holds true, 2020 sales will still trail 2018 levels.

The last few years have seen the proliferation of smartphones and other consumer electronics gadgets, as well as cloud infrastructure buildouts. With smartphone demand moderating and IoT demand accelerating, both these segments are likely to be 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 account for the current weakness in this industry. Foundry spending has already started to pick up, the strong growth in major foundry equipment supplier KLA Tencor’s (KLAC) earnings estimates is evidence.
• China is playing a larger role (as a consumer) because of the government’s initiative to make the country a major producer of semiconductors. But there’s a certain opacity to Chinese functioning that brings uncertainty to the market. Add to that the real concern that China will produce so much that prices will fall further. The trade war also isn’t helping things.
• 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 (10nm and 7nm), 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.

Zacks Industry Rank Indicates Continuing Challenges

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 #198, which places it in the bottom 22% 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 bottom 50% of the Zacks-ranked industries is a result of deterioration in the earnings outlook of constituent companies in aggregate. The industry’s aggregate earnings estimate revisions in the past year of a 25.0% decline for 2019 indicates negative 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 Lags 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 lost 37.6% over the past year, while the Zacks S&P 500 Composite and Zacks Computer and Technology Sector gained 2.3% and 1.6%, respectively.

While the industry is small, players like Applied Materials (NASDAQ:AMAT), Lam Research and ASML Holding (AS:ASML) NV 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 21.0X compared to the S&P 500’s 17.2X. It is also slightly above the sector’s forward-12-month P/E of 20.5X.

Over the past year, the industry has traded as high as 21.0X, as low as 12.4X and at the median of 16.7X, as the chart below shows.

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

Bottom Line

As evident, the market is expected to get a bit worse before it gets better, as in all cyclical industries that go through periods of relative weakness. But there are secular drivers of semiconductor demand that are positive for the wafer fab equipment makers after 2020.

Here’s a list of stocks that display the above characteristics-

Lam Research (LRCX): The stock has gained 55.1% over the past year. The Zacks Consensus Estimate for the 2021 EPS (year ending June) is up 74 cents in the last 60 days.

Price and Consensus: LRCX

Applied Materials (AMAT): The stock has gained 33.5% over the past year. The Zacks Consensus Estimate for the current-year EPS is up 3 cents in the last 60 days, for 2020 it is down 20 cents.

Price and Consensus: AMAT

ASML Holding NV (ASML): The stock has gained 32.1% over the past year. The Zacks Consensus Estimate for the current-year and next-year EPS are unchanged in the last 60 days. But they are down a respective 19 cents and 8 cents from 90 days ago.

Price and Consensus: ASML

5 Stocks Set to Double

Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.

Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.

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