We may know the top, do we know the bottom? What is the downside in NAND, DRAM, Foundry. Can China help or is risk worse than upside?
It would appear that our concerns in our preview piece prior to the AMAT call came true as the stock now has a “4” handle, NAND is in question and display is down.
However its not like business is falling off a cliff any time soon. The industry is clearly not like the bad old days when business fell off by 50% in a quarter, the industry is less volatile. Aside from the industry being more mature, so are the stocks, with dividends and significant buybacks.
Companies have enough excess cash to prop up EPS in a dropping market by buying back shares much as we saw in Applied’s just announced quarter. It may not seem like a lot but the combination of dividends and buy backs will cushion downturns at least from a stock perspective.
Customers are more rational. Rather than building new capacity in fab size chunks they have been modulating their capacity in smaller bites. We will get some exceptions such as display where Samsung came to an abrupt halt but that is an exception more than a rule and we also saw a huge uptick in OLED leading up to that abrupt stop.
However stocks still are volatile and react as we have seen in this 10% drop in AMAT. While we remain concerned about NAND spend, display, and slow foundry we are still intrigued by the upside in China. We saw over a $1B in sales by Applied.
Our problem is that the China upside brings with it huge political risk. Just as we thought the risk was going away, politicians started up new legislation aimed squarely at China and tech. We think that the upside in China could mitigate softness in NAND, foundry & display but the downside beta is huuuge as That $1B could go to zero inside of a quarter by the snap of a politicians fingers (see our preview in our recent April fools newsletter…)
In short the industry and stocks are at an interesting crossroad with conflicting currents yet to be sorted out.
NAND – We still like it but its getting old
The SSD revolution has been great. Iphones with 256GB of NAND are also great. The industry has been careful not to overbuild but we are sure that China wants to shoehorn its way into the NAND market and the way to do it is by price. Although we are way away from China being a force in NAND the existing supply/demand balance may be softening. The softening has not come from the supply side as it has been rational, the softening has come from the demand side which has not kept up. Capacity will not come off line as we finish up 2D to 3D conversions so we really need demand to pick back up.
TSMC, the world’s biggest foundry, made it clear on their call that demand was softening. They have been very good spenders going to 10NM. However we would point out that there is significant equipment reuse between 10NM and 7NM whereas there was not a lot of reuse going from 14NM to 10NM. This reuse issue , coupled with soft smart phone demand makes for weaker spend, likely for a year or more. We could see spend on EUV as the industry tries to migrate but less so in other areas.
Yield management still good
We still think the difficult EUV conversion coupled with new inexperienced players in China that need to figure out process bodes better for yield management and with it KLAC & NANO etc;. Indeed KLA has been a slight bit more positive in outlook than AMAT or LRCX and the stock has also outperformed.
Subsuppliers – MKSI, AEIS, ICHR, UCTT etc…
As expected these companies are off in sympathy to their customers as well they should be. However, we would point out that they are more diversified and somewhat less levered to their customers fortunes and misfortunes as the case may be. Their performance has been very good and the stocks have held up much better than in previous cycles when they were at the end of the whip or bottom of the hill as things flowed downhill. They are much more resilient now.
In terms of the stocks, we might get interested again in Applied in the mid $40’s. We could potentially see another round trip to the mid $50’s but we think it will be harder to crack $60 given the headwinds now present. We doubt that news will improve after the current quarter is reported and we have the China sword returned to a position above our heads. Analysts who were bullish going into the quarter have lost some credibility and the dreaded “C” word (cyclicality) is being used again.
We still like KLAC as the copy least impacted by most issues (perhaps with the exception of China). ASML will likely see improving EUV business but that may not boost earnings as margins remain poor versus DUV so we are not intrigued by that play.
We still like Micron for being dirt cheap and see continued strong profits.