The semiconductor capital goods industry has been equated with the “arms dealer” of the semiconductor industry. Buying into the sector depends less on who wins, and more on whether the battle requires massive combat capability.
NVIDIA (NVDA) has an initial lead in artificial intelligence chips and depends on massive capacity expansion to meet growing demand, while advances in micro-devices (AMD) plans to introduce its M1300X chip later this year. Additionally, Amazon (AMZN) , Alphabet (GOOGL) , Apple (AAPL) and others are designing AI-related silicon for their own use.
Regardless of how this fight for AI supremacy plays out, semi-cap equipment companies including Applied Materials (ENORMOUS), KLA Corp. (CLUTCH), Search Lam(LRCX) and ASML Holding (ASML) , stand to win.
A long thesis for the semiconductor capital goods industry is starting to come to fruition with government incentives bringing in huge investments in new chip factories. Including the CHIPS Act, the combined global incentives amount to approximately $66 billion per year over the next five years for the relocation of manufacturing capacity to home countries. In recent days, Intel (INTC) announced a new $25 billion chip fab in Israel, a $4.6 billion factory in Poland and two state-of-the-art facilities in Germany totaling $33 billion thanks to $12 billion in incentives .
As Intel rolls out its foundry capability to potential chip customers to compete with Taiwan Semiconductor (TSM) and Samsung, one of the selling points is the diversification of the chip supply outside of Asia. With supply chains shifting out of China and concerns over the concentration of chip manufacturing in Taiwan, Intel’s penetration into the foundry industry will be closely watched.
The tailwind for semiconductor capital goods inventories from new factories may support the group, which has already posted recent gains on the back of a surge in AI-related orders.
Jefferies considers the semi-capitalized equipment sector, including Applied Materials, Lam Research, KLA Corp. and Teradyne (TER) , while the undiscovered AI is playing. They note: “AI requires larger parallel processing chips than traditional server processors, so data center chips are getting larger and larger, greatly increasing the demand for semi-cap equipment. To make chips bigger, you also need to implement new chip architectures, which require a whole new set of advanced packaging and testing equipment.”
It should be noted that because the group recently rallied around AI stocks, Jefferies’ “undiscovered” thesis is being discovered. Nevertheless, advances in AI will increase chipmakers’ capital expenditures for years to come.
Nvidia is reportedly pressuring Taiwan Semi for up to 50% more supply for 2024. Nvidia’s wafer usage has already increased nearly 50% since the start of 2023. Taiwan Semi’s investment needs, currently projected between $32 billion and $36 billion for 2023, will be closely watched by Wall Street for increased capacity needs, with expectations that demand for AI alone will impact the semi-cap equipment sector.
Sector profitability has increased significantly over the past decade, helped by improved consolidation margins. The group trades at reasonable valuations, with P/E multiples typically between 16x and 18x, and they return a large portion of cash flow to investors through buybacks and dividends.
The downside case is the overall expansion of new fabs and capacity comes as wafer fabrication equipment/sales hit a 15-year high, and industry overinvestment will cause a significant slowdown. While the industry still faces the risk of cyclicality and excess capacity, the semi-industrial industry appears to be emerging from a cyclical downturn as excess inventory is currently being reduced.
Data center owners and others investing in AI are creating a new upswing in chip demand. AMD CEO Lisa Su predicted that the industry is expected to grow 50% annually to reach $150 billion over the next five years.
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