Chip Equipment's Bright Prospects Are Etched in Stone and Silicon
We see strong growth and reduced cyclicality for the industry.
The wafer fabrication equipment space has been historically cyclical but has enjoyed stellar growth over the past five years thanks to sustained investment by leading-edge logic, foundry, and memory customers. The $50 billion-plus market is dominated by five major suppliers--Applied Materials (AMAT), ASML (ASML), Lam Research (LRCX), KLA (KLAC), and Tokyo Electron (8035)--which account for over 70% of the market and represent an integral part of the semiconductor ecosystem.
We foresee reduced cyclicality for the industry, thanks to consolidation of key customers and an increase in end-market diversity beyond PCs and smartphones toward the public cloud, 5G network rollout, a rise in automotive chip content, and artificial intelligence chip proliferation. Past downturns created challenging conditions for equipment suppliers and chipmakers alike to maintain investment levels and development of new chips or tools. We believe chipmakers (especially memory customers) are better equipped to navigate downturns with greater cash cushions and profitability levels, thanks to consolidation and more rational behavior from a supply/demand standpoint. With both the supplier and customer bases down to a smaller cohort (including the five aforementioned equipment vendors and chipmakers such as TSMC (TSM), Samsung (SMSN), Intel (INTC), and Micron (MU)), we think the wafer fabrication equipment market is now more supportive of consistent and resilient excess returns.
Over the next five years, we think this market will see a 6% compound annual growth rate, with the proliferation of extreme ultraviolet lithography, higher-layer-count 3D NAND, and new transistor structures supporting demand for more advanced tools. China also represents a strong growth opportunity for wafer fabrication equipment, though not without risks, as ongoing U.S.-China trade tensions may lead to additional export restrictions for U.S. companies. Additionally, we expect the top five suppliers to outperform the industry growth rate, thanks to share gains and services growth. Four of the top five players warrant wide economic moats thanks to cost advantages and intangible assets. The fifth, Tokyo Electron, has a narrow moat rating. Our top picks are Lam Research and KLA in terms of opportunity in upcoming technology transitions. We would be avid buyers on a pullback.
Our Top Picks
We expect the top five suppliers to outpace the broader wafer fabrication equipment market over the next five years through a combination of market share gains and services strength. On average, we foresee a 9% revenue CAGR over the next five years for the top five, ahead of the 6% CAGR for overall wafer fabrication equipment spending. Of the top five, we view the four wide-moat companies (Applied Materials, ASML, Lam Research, and KLA) favorably, though all are trading either at or above our fair value estimates. Each of these suppliers boasts enviable qualities: ASML as the EUV leader; Applied Materials as the large and well-diversified vendor; Lam Research as a strong innovator poised for solid share gains; and KLA as the dominant PDC supplier primarily responsible for enabling many of the key process technology transitions.
We believe Lam Research is well positioned to gain additional market share in critical etch and deposition segments, in addition to served addressable market expansion via new products in the atomic layer deposition and photoresist processing equipment segments.
KLA is the leader in process diagnostic and control tools, which help chipmakers inspect wafers for defects and proper critical dimensions to identify and correct problem sources. As chips increase in complexity and ramping up new process technologies face new challenges, KLA’s tools help the industry improve yields, accelerate product ramp-ups, and maximize profitability. We think KLA is a pure-play bet on increasingly sophisticated semiconductors as a result of the slowing of Moore’s Law. Additionally, KLA has shown it can maintain decent levels of growth even during years of wafer fabrication equipment contraction, such as 2019.
This information was published as part of a larger report, which is available to Morningstar’s institutional clients.
Abhinav Davuluri does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.