AMAT - Tokyo Electron: World's Second-Largest Equipment Company Is Oversold As Japan Sanctions On China Begin

2023-08-21 16:58:50 ET

Summary

• Tokyo Electron reported a 29.8% QoQ decrease in sales and a 45.8% QoQ decrease in net income for Q1 2024.
• The company attributed the decline to weak demand for final products and adjustments in semiconductor memory inventories.
• Tokyo Electron expects sales for the first half and full fiscal year to be JPY790 billion and JPY1,700 billion, respectively, with a YoY change of -23.0%.
• TEL maintains a dominant share of Dielectric Etch ahead of Lam Research, a 90% share of resist coating required with ASML systems, and is the No. 3 company in the global semiconductor industry.

Tokyo Electron Ltd. ( TOELY ) ("TEL") released its financial results for the fiscal first quarter of 2024 (April to June), posting sales of JPY391.7 billion (US$2.7 billion), -29.8% QoQ and -17.29% YoY, and a net income of JPY64.3 billion, compared to JPY88.1 billion, with a QoQ change of 45.8%.

TEL attributed its financial performance to weak demands for final products such as PCs and smartphones. Inventories of semiconductor memory adjusted, and semiconductor memory manufacturers curtailed production and capital investments. But capital investments for automotive and industrial applications continued their strong trends from the previous fiscal year.

For guidance, TEL expects sales to be JPY790 billion and JPY1,700 billion for the first half and full fiscal year, respectively. YoY change is expected to be -23.0%. Operating income and net income for fiscal 2024 are expected to be JPY393 billion and JPY300 billion, respectively, with YoY change expected to be -36.4%.

Japan Sanctions on China

China Sanctions Analysis

Japan was more or less unaffected by semiconductor sanctions imposed by the U.S. on China. However, under pressure from the U.S., Japan issued new export restrictions on 23 types of chip-related equipment and materials, which came into effect in July 2023.

The list includes all immersion lithography scanners, etching equipment, tools for chemical wafer polishing, and extreme ultraviolet (EUV) mask-testers, according to DigiTimes .

These equipment systems are manufactured by 10 companies including Tokyo Electron ((TOELY)) and Nikon ( NINOY ), discussed in this article, as well as Lasertec ( LSRCF ), SCREEN Holdings ( DINRF ), and Kokusai Electric.

It's important to recognize these sanctions align with similar restrictions enforced against China by the U.S. and The Netherlands in recent quarters. Unfortunately, they come at a bad time for Japanese equipment companies.

Not surprisingly, China responded with sanctions of its own, in which Chinese companies must obtain an export license to export gallium and germanium metals, as well as any products containing these elements. Japan is the world's largest consumer of gallium, according to the Japan Organization for Metals and Energy Security, which means that these new regulations will impact Japanese companies.

Japan Sanctions impact on Tokyo Electron

While sanctions have been in place after the recent quarter, the impact isn't known. In fact, China is the only region where Tokyo Electron saw growth in the last quarter, as shown in Table 1.

Importantly, these sanctions were first planned in January 2023, and customers have adjusted their strategies, buying in anticipation of the forthcoming sanctions.

In June, imports of Japanese chip-making gear reached US$804 million, up 41.6% QoQ and -10.5% QoQ. In anticipation of sanctions, Chinese semiconductor companies increased purchases of lithography systems by 137.1% QoQ., reaching a value of $62.4 million. Additionally, the value of etching and stripping machines brought into Japan surged by a remarkable 370.1%, amounting to $44.4 million. TEL is a leading manufacturer of etching systems, according to our report entitled Global Semiconductor Equipment: Markets, Market Shares and Market Forecasts .

Overall Japanese Semiconductor Equipment Analysis

However, in the first sixth months of the year, the total value of China's chip equipment imports from Japan decreased 13.2% to $4.83 billion, in line with the downward trend in chip imports during the same period, reflecting expanded US efforts to limit China's access to advanced chips and related equipment.

China's total imports of semiconductors from South Korea plunged 19.6% in the period compared with a year ago, while imports from Japan and Taiwan fell 11.1% and 18.9%, respectively.

In Chart 1, I show equipment billings of Japanese equipment companies on a monthly basis between 2015 and 2023. Billings in 2023 (red lines) have dropped considerably in the past two months.

Chart 1

On July 6, 2023, SEAJ (Semiconductor Equipment Association of Japan) presented its forecast for FY2023 (from April 2023 to March 2024):

"In fiscal 2023, we forecast a 23% decrease from the previous fiscal year to 3.02 trillion yen, factoring the impact of changes in advanced factory plans due to the US export restrictions on China and the impact of reduced capital investment due to the decline in memory prices."

Incidentally, in my June 25, 2021 Seeking Alpha article entitled Applied Materials: Tracking A Likely Semiconductor Equipment Meltdown In 2023 , I presented my thesis for a sharp downturn in 2023 that will extend into 2024.

In my article, I warned that excessive capex spend would give rise to an oversupply of semiconductors and a drop in equipment spending in 2023. The poor fiscal and monitory policy coming from the U.S. Fed has pulled in the downturn into 2022, particularly in the memory sector.

Analyzing Tokyo Electron

Tokyo Electron is one of the leading semiconductor equipment companies, with a leading market share in several processing equipment sectors, and second only to Applied Materials (AMAT) in global revenues. Shown in Chart 2 are TEL's revenues by fiscal year ending March. Even though its percentage of sales for Etch system dropped in FY23, it still maintains a dominant share of Dielectric Etch (ahead of Lam Research (LRCX) and Tube LPCVD (ahead of Kokusai Electric), according to our report entitled Global Semiconductor Equipment: Markets, Market Shares and Market Forecasts .

Chart 2

However, in correlation with Chart 1 above for Japanese equipment suppliers, Chart 3 shows that TEL's HoH revenues dropped 18.9% in first half 2023. Yet, the company outperformed LRCX, which exhibited a -29.9% HoH revenue change. Japan's Screen Holdings were also negative, with a -6.8% change. KLA ( KLAC ) changed just +0.8%, but the clear leader is ASML at +69.8%.

I forecast that ASML will overtake Applied Materials as the leading equipment company for CY 2023.

Chart 3

Table 2 shows TEL's quarterly semiconductor equipment revenues, showing an overall equipment change of -33.4% and a large drop in exposure to Foundry/Logic customers, although it follows the previous quarter with a +25.4% growth.

Investor Takeaway

Tokyo Electron was the third-largest semiconductor equipment company in 2022 behind Applied Materials and ASML. In its recent earnings call, the company attributed a 17% YoY drop in revenues on weak demand for final products such as PCs and smartphone, the same cause that Micron (MU) and other chip companies have been saying for several quarters.

This weak demand for consumer electronics may have been responsible for weak performance for the company in the past quarter. What in this article I attempted to provide to readers, that weakness will persist through 2023 and into 2024. These include:

• An oversupply of chips, primarily caused by excess WFE spend in 2021 that resulted in excessive equipment purchases that resulted in more chips made than needed.
• The macroeconomic factor that curtailed purchases of consumer electronic products at a time when consumers needed to spend discretionary money on higher prices for food, fuel and housing, which exasperated the oversupply of chips and increased inventory.
• China revenues were strong for TEL (Table 3) in anticipation of a sanctions, and the sales drop in Q1 2023 in Table 3 are also for pull-ins of foreign equipment from other companies and from sanctions from the U.S.
• U.S. sanctions had handed domestic equipment suppliers an opportunity, but Chinese semiconductor companies prefer non-Chinese equipment at this time, and locally-procured semiconductor equipment in China's foundries accounted for just 15% of the total.
• TEL, with a 90% share of the wafer coating and developing system market, crucial in assisting the ASML lithography process.

On a competitive basis, as I said above, TEL maintains a dominant share of Dielectric Etch ahead of Lam Research, a 90% share of resist coating required with ASML systems, and is the No. 3 company in the global semiconductor industry behind AMAT. Yet, its share price underperforms both competitors, as shown in Chart 4.

Chart 4

AMAT reported earnings a week ago with much fanfare. Looking beyond the hyperbole, QoQ revenues were -6% last quarter, following-3.6 QoQ the previous quarter.

Foundry revenues increased to 79% from 65% YoY, but conversely, memory revenues decreased to 21% from 35% YoY. And memory revenues will stay in the toilet through 2023. Total CY 2023 revenues will be -20% for semi for AMAT.

Foundry revenues were $4,180 in the previous quarter vs. $3,696 in the recent quarter. So, Foundry revenues were -12% QoQ, yet the hype as the company noted foundry increasing to 79%. QoQ, foundry dropped from 84% the previous quarter.

TEL is oversold, and I rate the company a Buy. I rate LRCX a hold, and I rate AMAT a Sell.

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