TOELY - Tokyo Electron: Drift To Buy

Summary

• We believe Tokyo Electron is still facing supply chain issues due to its low % of finished products despite its inventory turnover ratio decreasing to 2.00x.
• We expect the company’s DRAM segment revenue growth to remain superior to the NAND segment growth at the market CAGR of 7.3% to 5%.
• We forecasted its 5-year forward growth at an average of 8.8% supported by its Logic segment growth with its top customers including TSMC and Intel which had superior capex growth.

In this analysis of Tokyo Electron Limited ( TOELF ), we examined the company following its strong growth during FY2022 of 30.3%. This strong growth propelled it from the 3 ^rd highest market share in 2020 to the highest in 2021. However, we examine the company’s inventory turnover to identify the potential reasons which could include supply chain issues for its recent drop in quarterly revenues by 16.1% QoQ. Following this, we examine its revenue breakdown by Logic and Memory segments and projected its revenue growth going forward.

High Growth Despite Supply Chain Issues

Source: Company Data, Seeking Alpha, Khaveen Investments

As seen in the table above, Tokyo Electron’s revenue growth in 2021 and its 5-year revenue CAGR are 2.4% and 0.2% above its respective averages. We analyzed the company to determine if it has superior supply management as compared to its other competitors which allowed it to increase its YoY growth % from 20.5% to 30.3% over the past fiscal year.

According to the recent Q1 FY2023 earnings briefing, management has indicated that...

some sales were recognized in Q4 by putting forward the shipment because of high demand.

Management also stated...

on the other hand, there are some shipments shifted to the second quarter as well.

To understand the impact of supply chain disruptions on Tokyo Electron, we analyzed the company’s inventory turnover over the past 5 years and compared it to its competitors.

Source: Tokyo Electron, Khaveen Investments

As previously mentioned in our research of Texas Instruments (TXN), the...

company inventory turnover ratio measures its COGS over average inventory and indicates strong sales with higher ratios but could also signal its inventory is not enough to support its sales.

The company’s turnover ratio was on an increasing trend from FY2020 to FY2022, largely in line with its above industry 5-year revenue CAGR. An increasing number of days inventory outstanding from 161 days to 183 days also indicates a reduction in sales or a surplus in supply, as well as it being higher than its 10-year average of 168 days.

Source: Company Data, Khaveen Investments

Despite its efficiency ratios below its 10-year averages, Tokyo Electron fared average among other semiconductor equipment manufacturers. Applied Materials and Lam Research have consistently led in inventory turnover ratios whereas ASML and KLA have lagged due. Notably, all the companies mentioned were below their 10-year averages.

Source: Tokyo Electron, Khaveen Investments

As seen above, finished products as a % of total inventory have dropped from an average of 63.0% to 39.3%, likely due to the increase in sales made in Q4 FY2022. WIP, raw materials and supplies have more than doubled since FY2021, indicating that management has taken efforts to prevent a shortage of parts to reduce supply chain disruptions. We can see that COGS increased by JPY32 bln, which is a lower growth compared to its total inventory increase of JPY83 bln, thus resulting in a decrease in the inventory turnover ratio from FY2022 to TTM. Thus, we believe Tokyo Electron is still facing supply chain issues due to its low % of finished products despite its inventory turnover ratio decreasing to 2.00x.

There is also a high correlation between COGS and revenue growth as both have moved in tandem over the past 5 years. Since management brought forward sales from Q1 FY2023 to Q4 FY2022, revenue growth has further increased despite a sharp drop in finished products. However, as we continue to see finished products as a % of total inventory under 40%, we do not expect Tokyo Electron to be able to continue its high growth.

Superior Growth In DRAM

Source: Tokyo Electron , Khaveen Investments

Tokyo Electron’s revenue is broken down into its Logic and Memory segments, its Memory segment consists of NAND and DRAM revenues. Based on the table above of Tokyo Electron’s revenue breakdown by NAND and DRAM segments, its DRAM segment shows superior growth with a higher 5-year revenue CAGR of 19.7% from FY2018 to FY2022 compared to its NAND segment at a CAGR of -0.1%. We compared Tokyo Electron's segment revenue growth with the DRAM and NAND semiconductor market revenue in the table below.

Source: WSTS, IC Insights, Trendforce, Khaveen Investments

As seen above, the DRAM market grew at a higher 5-year CAGR at 7.3% compared to NAND at 5%. This is in line with Tokyo Electron where its DRAM segment outperformed its NAND segment. Thus, we attribute its outperformance to the superior DRAM market growth compared to the NAND market. According to our analysis on Micron (MU) previously, we analyzed the increase in DRAM pricing and “attributed rising demand for DRAM” as well as the “shift towards DDR5 further supports our forecast for DRAM pricing to increase going forward with the existing price premium”, which we believe are fundamental reasons for the superior growth of the DRAM market.

Source: Tokyo Electron, Khaveen Investments

Therefore, we expect the company’s DRAM segment revenue growth to remain superior to the NAND segment growth and projected its revenue growth based on the historical 5-year DRAM and NAND market CAGR of 7.3% and 5% respectively which translates to revenues of JPY 414 bln for its NAND segment and JPY555 bln for its DRAM segment by 2027.

Increasing Sales From The Logic Segment

Source: Tokyo Electron , Khaveen Investments

Furthermore, we compared Tokyo Electron's revenue between its Logic and Memory segment (comprised of NAND and DRAM) in the table above. The company’s Logic and Memory segments were similar in size at JPY784 bln and JPY715 bln in revenue respectively, but its Logic segment had a higher 5-year CAGR of 27.3% compared to its Memory segment at only 8.5%.

Source: WSTS, IC Insights, Trendforce, Khaveen Investments

Based on the table above of the Logic and Memory semiconductor market, the Logic semiconductor market had a higher 5-year CAGR of 10.9% compared to the Memory market at a CAGR of 6.3%. This is a similar trend with Tokyo Electron where its Logic segment had superior growth compared to the Memory segment above.

Source: Tokyo Electron, Khaveen Investments

According to its annual report, Tokyo Electron’s top 3 largest customers are Samsung, Intel and TSMC representing 42.1% of revenue. We analyzed the company’s customer capex in the following table below. These companies’ capex is important for Tokyo Electron as the company’s revenue is derived from these companies’ capex spending.

Source: Tokyo Electron, Khaveen Investments

As seen, TSMC, the company’s 3 ^rd largest customer had the highest 5-year CAGR for its capex at 27.8% followed by Intel, its second-largest customer at 12.4% while Samsung has the lowest CAGR among the 3 companies at 12%. Overall, this highlights the superior growth of its pure-play logic customers' capex which we believe explains Tokyo Electron’s Logic segment outperformance to its Memory segment.

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