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Semiconductor WFE Stock Outlook: Not Much Upside in the Cards

Sejuti Banerjea
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Semiconductor WFE Stock Outlook: Not Much Upside in the Cards

Researchers are divided on wafer fab equipment spending this year with Gartner projecting a 6% increase followed by cyclical correction in 2019 and 2020 after which the market is expected to return to growth. SEMI however sees 11.7% growth this year to $50.8 billion, with the front end growing stronger than the back-end.

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.

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.

As far as installed capacity is concerned, memory manufacturers are likely to remain the biggest spenders although foundries are also expected to remain strong. Technology transitions, an important consideration for equipment purchases are also expected to remain a driver due to the move toward larger wafer sizes (fab upgrades to 300mm, continued demnd for 20mm and development starting for 300mm in 2018-19 according to Technavio), 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 other drivers.

Industry Offers Solid Shareholder Returns

The Zacks Semiconductor-Wafer fab Equipment Industry, which is a stock group within the broader Zacks Computer And Technology Sector, has outperformed both the S&P 500 and its own sector over the past year.

So we see that the stocks in this industry have collectively gained 23.0% over the past year, while the Zacks S&P 500 Composite and Zacks Computer and Technology Sector have rallied 15.6% and 17.9%, respectively.

While the industry is small, players like KLA-Tencor, Applied Materials, Lam Research and ASML Holding NV are very important players. 

One-Year Price Performance


Wafer Fab Equipment Stocks Look Reasonably Valued

The strong run in share prices over the past year have however led to a relatively rich valuation.

Since the industry is made up of relatively mature companies, earnings flow is usually steady. So the industry’s 1.04X price to forward earnings growth (PEG) is well below the 1.76X for the S&P 500. At the moment, it also happens to be below the annual high of 1.17X as well as the 1.06X median.


Similar is the case when compared to the sector’s 1.78X.


But it probably makes more sense to value the industry based on sales and book value because this is a highly capital intensive business and success depends on the ability to provide the most advanced equipment and related customer service.  

The industry currently has a price to trailing 12 months’ sales ratio of 5.48X, which is below the annual high of 7.39X and the median level of 6.39X, suggesting the possibility of some upside. Comparing this with the S&P 500, we see that it is however ahead of its 3.40X (median 3.31X). 

Comparing the industry to the S&P 500 on the basis of price to trailing 12 months’ sales, we see that the industry’s 5.48X is ahead of the sector’s 3.72X.  


Comparing with the S&P 500 on the basis of price to trailing 12 months’ book value, we see that the industry’s 9.28X is just short of its annual high of 9.75X but ahead of the median 8.76X. It’s also ahead of the S&P 500’s 3.94X. 


It is also ahead of the sector’s 4.29X.


So while there appears to be some risk based on valuation, there may also be some opportunities as well.

The Earnings Outlook Is Not So Great

With semiconductor demand remaining strong on account of cloud computing, big data, IoT, auto and other mass market adoption, costs coming down for NAND makers (where demand is more elastic) coupled with increased supply from improved yields and foundries racing to meet customer demand amid stiff competition, the demand scenario appears robust.

However, the nature of the business necessitates heavy investments on the development of new technology as device complexities increase. The cost of development is so high that customers may at times finance development directly or through an equity purchase (as Intel, Samsung and TSM did in ASML).

The above ratio analysis shows that while there could be some risks, there may be some opportunities as well. A quarter-to-quarter analysis is not really meaningful for the industry. At the same time, investors will continue to question whether this group has the potential to perform better than the broader market in the quarters ahead.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. 

Price and Consensus: Wafer Fab Equipment Industry

This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $1.61 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks WFE industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $1.61 'per share' of the industry for 2018, but how this dollar number has evolved recently.

Current Fiscal Year EPS Estimate Revisions


The Zacks Industry Rank Indicates Opportunities

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks WFE industry currently carries a Zacks Industry Rank #37, which places it at the top 14% 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.

Our proprietary Heat Map shows significant fluctuation but ultimate improvement in the industry’s rank over the past five weeks.


Semi-WFE Stocks Promise Long-Term Growth

While near-term issues could bring varying results to investors, the estimated long-term (3-5 years) EPS growth for the Zacks WFE segment is attractive. Despite correction over the past year, the group’s mean estimated long-term EPS growth rate of 14.88% compares favorably with the 9.82% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate


The long-term growth is a continuation of strong performance over the past few years. Take revenue for example, which has gained momentum since 2016.


The net income before non-recurring items tells the same story.


While the debt level spiked in the beginning of 2017, the debt cap remains reasonable.


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 underlying drivers are extremely strong, so for investors looking to invest for the longer term will make attractive gains.

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

KLA-Tencor (KLAC): The stock has gained 27.4% over the past year. The Zacks Consensus Estimate for the current-year EPS is up 4.7% in the last 30 days.

Price and Consensus: KLAC


Applied Materials (AMAT): The stock has gained 11.2% over the past year. The Zacks Consensus Estimate for the current-year EPS is down 3 cents in the last 60 days, of which the decline in the last 30 days was a cent.

Price and Consensus: AMAT


ASML Holding NV (ASML): The stock has gained 34.7% over the past year. The Zacks Consensus Estimate for the current-year EPS is up a couple of cents in the last 60 days.

Price and Consensus: ASML


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