Summary
- Applied Materials is being impacted by a recent escalation of sanctions on China by the U.S. Government.
- The dour economy is forcing Applied's memory customers to make significant cuts in capex spend.
- A double-digit drop in 2023 WFE equipment revenues is around the corner.
- Rumors of new sanctions on FPD Display equipment to China are being reviewed by the U.S. Government.
Applied Materials ( AMAT ) announces its Fiscal Q4 2022 earnings on Thursday, Nov. 17. In the previous four earnings calls, the company missed revenue two of four quarters, and missed earnings two of four quarters.
In this article, I will address two headwinds that AMAT currently is facing, one headwind that will impact the company in 2023 going into 2024, and one potential headwind that may surface in the near term.
Impacted by Memory Capex Cuts
In my Aug, 15, 2022, Seeking Alpha article entitled “ Applied Materials: Navigating 2 Successive Equipment Downturns ,” I discussed the impact of the current cutbacks in capex spend from memory companies, primarily Micron ( MU ) and SK hynix ( OTC:HXSCL ) due to the impact of the dour economy on consumer electronics products.
- Micron indicated it would reduce 2023 capex by 30% in capex, which includes 50% equipment and 50% building, which would imply a 15% cut in equipment. But MU is actually cutting back WFE equipment purchases 50% in fiscal 2023, a significant impact on equipment suppliers to the company. On Nov. 16, 2022, MU announced even further cuts, stating: "In order to significantly improve total inventory ... DRAM bit supply will need to shrink and NAND bit supply growth will need to be significantly lower than previous estimates."
- SK hynix announced in late October it plans to reduce its investment next year by more than 50 percent due to poor demand in memory chip business. The move comes after the company’s third quarter operating profit fell to 1.7 trillion won ($1.2 billion), missing analysts’ estimates of 1.87 trillion won. Revenue fell 7 per cent to 11 trillion won.
Table 1 shows semiconductor revenues for memory chips (DRAM and NAND) by equipment company. It's important to note these are equipment sales only, and do not include service or spare parts). AMAT generated the largest revenues from equipment sales for memory chip production in 2021 for a total of $6.8 billion in revenues. This was followed by Lam Research ( LRCX ), Tokyo Electron ( OTCPK:TOELY ), ASML ( ASML ), and KLA ( KLAC ).
Impacted by China Sanctions on Semiconductor Equipment
When one would think things couldn’t get worse for AMAT, on Oct. 7 the U.S. government imposed sanctions on semiconductor equipment exports to mainland China. I discussed the impact in an Oct. 12, 2022, Seeking Alpha article entitled “ Memory Collapse And China Sanctions: Equipment Companies Most Impacted ,” noting that:
“AMAT revised its estimates after market close on Oct. 12 that the new regulations will reduce its fourth-quarter net sales by approximately $400 million, plus or minus $150 million. The revised net sales outlook reflects the impact of the new export regulations partially offset by supply chain performance improvements.”
Investors must recognize that on Oct. 12 when AMAT issued this press release , the company had only about two more weeks of operation before the end of its fiscal fourth quarter, which will be presented on Thursday. While the spread of the revised estimate was large, it will most likely come in at that range.
Most importantly, with respect to the upcoming earnings call, AMAT in its press release reported:
“The company currently expects the new regulations will impact net sales in the first quarter of fiscal 2023 by a similar amount as in the current quarter.”
Thus, guidance for Q1 2023 will be noteworthy as AMAT negotiates the impact of these Sanctions.
AMAT wasn't alone in announcing the impact of the sanctions. Lam and KLA also announced its impact following the announcement of the sanctions.
- Lam Research warns of up to $2.5 bln revenue hit from U.S. curbs on China exports
- KLA estimates up to $900m revenue hit in 2023 from China chip ban
Chart 1 shows AMAT’s performance compared to Chinese and non-Chinese equipment companies, showing YoY growth for 3Qs 2022 vs. 3Qs 2021. There are two takeaways from the Chart:
Chart 1
The mean growth for non-Chinese companies for the nine-month period was 11.2%, and AMAT’s performance of just 8.7% (based on guidance for Fiscal 4Q) indicates underperformance against other WFE competitors.
The mean growth for Chinese companies was 62.8%, indicating that Chinese equipment companies are gaining in the market, although their revenues are significantly lower than non-Chinese counterparts, according to Tour report entitled “ Mainland China’s Semiconductor and Equipment Markets: Analysis and Manufacturing Trends .”
Impact by Foundry/Logic Capex Cuts
While memory companies are cutting capex spend in 2022/2023, the worst of logic/foundry equipment is yet to come. On June 24, 2021, I published on Seeking Alpha an article entitled “ Applied Materials: Tracking A Likely Semiconductor Equipment Meltdown In 2023 .”
Chart 2 shows the strong equipment revenues generated by North American equipment companies in 2020 and particularly 2021, and already a slowdown in 2022 as a result of the capex overspend.
I had projected a meltdown in equipment revenues 2023, as discussed in my above article, and within the past few months, nearly all analysts have reduced WFE equipment spend for 2023 to approximately -20%, in corroboration with my analysis 18 months ago.
Chart 2
Table 2 shows semiconductor revenues for foundry/logic by equipment company. ASML generated the largest revenues from equipment sales for foundry/logic chip production in 2021 for a total of $11.3 billion in revenues. This was primarily due to sales of EUV lithography systems to Samsung, TSMC, and Intel.
AMAT was a close second with foundry/logic revenues of $10.5 billion. In 2021, AMAT generates overall revenues of $8.7 billion in deposition and $3.1 billion in etch, and both types of equipment were responsible for 50% of revenues. With foundry/logic revenues representing 60% of AMAT’s overall revenues, much of the foundry/logic revenues are from deposition and etch. These equipment types are used in multiple patterning processing with DUV lithography processes to get nodes down to 2021 state-of-the-art of 5nm.
Impact of China Sanctions on Display Equipment
China is the leader of the worldwide display market with a 40% share, compared to Korea at 30%. In the LCD (liquid crystal display) segment in 2021, China’s held a 50.9% share compared to 31.6% for Taiwan and 14.4% for Korea, according to our report entitled “ OLED and LCD Markets: Technology, Directions and Market Analysis .”
In the organic light emitting diode ("OLED") panel segment, Korea dominates, but its share has dropped from 98.1% in 2016 to 82.8% in 2021, with share erosion to China, which gained share to 16.6%.
Shown in Chart 3 are AMAT’s display revenues between 2004 and 2021. The ramp in revenues in 2017 was due to a number of 10.5G plants used to make display glass for large area TVs. Using AMAT’s AKT equipment for deposition of the backplane, in 2018, BOE started the mass production of 10.5th-generation LCD panels for the first time in the world, which also is the starting point of China’s global display market domination. Unfortunately the increased supply of large display panels also contributed to a downturn in the display market as a result of a significant drop in panel prices.
Details of 10.5G can be seen in my March 5, 2018, Seeking Alpha article entitled “ Applied Materials' Display Segment Should Grow 10% In FY 2018 .”
Chart 3
Table 3 shows AMAT’s revenue for CY Q2 in 2020, 2021, and 2022 compared to leading equipment companies. AMAT has been the top company based on revenues with shares above 35% during this period, and any U.S. sanctions will strongly impact the company, particularly due to its dominance in 10.5G with plants primarily located in China.
Investor Takeaway
Applied Materials has had to address headwinds from U.S. semiconductor equipment sanctions and capex spend cuts from memory companies. Chart 4 shows that despite these headwinds, share price has risen dramatically over the past few weeks. But then again, competitors Lam Research and KLA are also growing strongly. Clearly KLAC has the best performance and AMAT a poor third.
Chart 4
These three companies are all facing the same headwinds and investors are buying shares as a sector rather than on an individual basis. I add VanEck Semiconductor ETF ( SMH ), illustrating that investors are buying and selling semiconductor equipment stocks as a sector. SMH's share performance coincides with LRCX for the past six months and share price for the one-year period is close, but higher than AMAT.
Current semiconductor sanctions imposed by the U.S. government largely impact U.S. chip and equipment companies. The U.S. has little leverage with foreign companies and is in negotiations with foreign governments to persuade them to also stop export of chips and equipment to China.
In fact, in the latest round of sanctions the U.S. has given Korean memory companies Samsung Electronics ( OTCPK:SSNLF ) and SK hynix just one year to continue to receive advanced equipment for its fabs in China. Samsung makes about 40% of its 3D NAND chips in China, whereas SK Hynix produces around 40% of its DRAMs.
There are headwinds facing AMAT and the upcoming fiscal 4Q earnings call should shed more light on the current impact. AMAT ideally will provide guidance for fiscal Q1 2023 and provide analysts and investors with more metrics.
For further details see:
Applied Materials: Awaiting F4Q Earnings As Headwinds Just Won't Go Away