- Excessive overbuild of Foundries in 2021-22 will result in oversupply of logic semiconductors in 2023 as I said in June 2021.
- Applied Materials, the largest equipment company with the largest exposure to Foundries, will be affected the greatest by significant revenue reductions.
- The dour and uncertain economy is adding memory chips to the mix primarily as a result of a slowdown of consumer products like PCs.
- One year after my initial assessment on the oversupply, analysts are finally lowering WFE equipment demand for 2023.
On June 24, 2021 I published on Seeking Alpha an article entitled “Applied Materials: Tracking A Likely Semiconductor Equipment Meltdown In 2023.” One year later:
- The economy of the U.S. and to a lesser degree most countries, has been turned upside down
- Analysts are just beginning to cut estimates of WFE sales in 2023, nearly a year after to the day after I published my thesis.
For example, UBS analysts in a June 28, 2022 cut earnings estimates and price targets on the group of semiconductor equipment makers, citing lower forecasts for the rest of the year and into 2023.
"We see major producers building inventories in hopes of demand improvement and we expect they will additionally cut capex and are already starting to push out tool shipments.”
Since then, Applied Materials’ ( AMAT ) share price decreased 8.7%.
In this article, with so many financial metrics that have changed in the past 12 months, I want to provide investors with an updated analysis for WFE (wafer front equipment) and semiconductor sectors.
Background to 2021 Analysis
Fundamentally in a semiconductor cycle, an expansion in semiconductor fabs results in a demand for semiconductor equipment used to make semiconductor chips. But the last few years have been atypical. Normally, semiconductor chip growth is about 6% per year and wafer front end ((WFE)) equipment growth is about 13% per year. But in 2020 and 2021, equipment purchases and semiconductor output were exceedingly large, as shown in Table 1, according to The Information Network’s report entitled “ Global Semiconductor Equipment: Markets, Market Share, Market Forecast .”
Fab construction continued unabated with 29 fabs built in 2021 and 2022 that could produce as many as 2.6 million wafers per month, according to SEMI consortia. Of these:
- 15 fabs are foundry facilities with capacities ranging from 30,000 to 220,000 wafers per month.
- 4 are memory fabs with higher capacities ranging from 100,000 to 400,000 wafers per month
Currently, new 300mm semiconductor volume fabs expected to begin operation from 2022 to 2025 raises the count to 199 volume fabs by 2025.
One Year Later - 2022
Macroeconomic Factors
The economy in 2022 is not the economy it was in 2021.
- Slowing economic growth rate in the United States
- Concern of recession
- Tightening monetary policy from the Federal Reserve
- Rising inflation rate
- Rising interest rates
- Residual global supply chain challenges
- Geopolitical concerns and residual damage like high oil prices
The macroeconomic malaise is impacting consumer purchases of end-products using semiconductors. In poor economic times, consumers choose food and fuel instead of smartphones. Chart 1 illustrates the current conditions in the U.S.
YCharts
Chart 1
According to the latest report from the Bureau of Labor Statistics, the annual inflation rate in May was 8.6%, its highest level since 1981, as measured by the consumer price index. The University of Michigan consumer sentiment was a record low of 50.0 in June of 2022.
Microeconomic Issues
Last week, Micron’s ( MU ) CEO reported in the company’s Q3 earning call that he expects PC and smartphone sales to decline in 2H2022. That set the stage for a consensus miss in Q4 revenues and a downgrade.
Bank of America analyst Vivek Arya downgraded Micron shares to neutral from buy, while cutting the price target, at the same time BofA also noted that Lam Research ( LRCX ), Applied Materials, and KLA Corp. ( KLAC ) are likely to be affected, as Micron plans to cut 2023 wafer fab equipment spending.
Table 2 shows capex spend YoY change by leading semiconductor companies from 2019 through 2023. Capex is a combination of building structure (fabs) and equipment in an approximate 50:50 ratio. It shows my adjusted capex spend for Micron and SK Hynix moderating in 2023, while Logic and Foundry capex spend from Intel ( INTC ) and TSMC ( TSM ) are expected to drop significantly from strong capex spend in 2022.
WFE for 2022-2024
Tied to my initial thesis from 2021, Chart 2 shows my WFE equipment forecast for 2022-2024 by chip type. The YoY change shows a significant drop in Foundry (orange line) between 2022-2024, while the other sectors recover in 2024. Note that my analysis shows WFE growing in 2022 but dropping in 2023 and again in 2024, in alignment with my contention that an overbought situation of equipment (Chart 1 above) will give rise to an increase in semiconductor supply, which will reduce the demand for equipment.
As I noted above of fab build, 15 fabs are foundry facilities with capacities ranging from 30,000 to 220,000 wafers per month. Only 4 are memory fabs with higher capacities ranging from 100,000 to 400,000 wafers per month.
Chart 2
Applied Materials Most Impacted
Taiwan is the home to the largest semiconductor foundries – TSMC and United Microelectronics ( UMC ). Thus, cuts in capex spend should affect equipment imports in Taiwan the greatest. In Table 3, I show individual equipment suppliers and their exposure to Taiwan by quarter. Applied Materials, the largest semiconductor equipment company, generated 1,025 million in revenues in Q1 2022, ahead of any competitor.
In addition to Taiwan being an epicenter of Foundry fabs, Korea’s Samsung Electronics’ ( OTC:SSNLF ) capex is projected to increase just 2% in 2023 as shown in Table 2 above, which is also a negative for AMAT.
Table 4 is another example of Applied Material’s exposure showing that Foundry represents 45% of its revenues in 2021 and logic another 11%. Thus, the cutbacks in Foundry and Logic capex for AMAT will have a significant impact on its financial metrics.
Investor Takeaway
AMAT Metrics
AMAT's share price is down 31.19% for the past 1-year and 42.98% YTD. It has been below its 200-day and 50-day moving average for nearly all of 2022, as shown in Chart 3.
YCharts
Chart 3
Chart 4 compares share performance for AMAT's competitors Lam Research ( LRCX ) and KLA ( KLAC ). It is worth noting that:
AMAT and LRCX are competitors in Deposition and Etch equipment. In fact, in 2021, 94% of Lam's revenues were in deposition and etch and 67% of Applied's revenues were in deposition and etch. This means they are strong competitors, and positive results for AMAT should mean negative for LRCX, since they are competing for sales from the same semiconductor customers. Yet, share performance is nearly identical indicating that investors buy semi cap stocks as a sector rather than performing a deep-dive analysis of each company.
In 2021, 94% of KLAC's revenues were in metrology/inspection but just 7% of AMAT's revenues were in metrology/inspection. KLAC's equipment demand increases as semiconductor technology node decreases. As the industry moves to smaller nodes requiring more sophisticated methods for inspection chips, KLAC is the better choice among the three.
YCharts
Chart 4
Chart 5 confirms my analysis that KLAC is the best of the three companies based on Seeking Alpha's ratings.
Chart 5
Seeking Alpha's Quant Factor Grades are shown in Chart 6. KLAC has the best grades while AMAT and LRCX nearly identical performance. Share performance in Chart 4 above matches Quant performance.
Chart 6
My original thesis in mid-2021 called for a market crash brought on by overbuild of Foundry fabs and a resultant oversupply of logic chips from Foundries. That remains intact.
The dour and uncertain economy is adding memory chips to the mix primarily as a result of a slowdown of consumer products like PCs and smartphones.
Reduced demand for consumer products will also have a follow-on impact on Foundry chips. My original thesis was that the oversupply of these chips would result in lowered ASPs. Now we add reduced demand, further exacerbating the problem.
Intel is a different subset, because most chips in its new fabs will be for internal use as the company also tries to gain traction as a Foundry.
My analysis illustrated in Chart 2 above shows two consecutive years of a downturn in 2023 and 2024, in which WFE equipment will exhibit a double digit YoY drop in 2023 and a low single digit drop in 2024. The extent of the impact of the macroeconomy will be a focus of my future analysis as I look further at 2024 and into 2025.
For further details see:
Assessing My 2021 Call For A Likely Semiconductor Equipment Meltdown In 2023 Impacting Applied Materials