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ASML most immune to slow down due to lead times Not LRCX

ASML most immune to slow down due to lead times Not LRCX
by Robert Maire on 10-21-2018 at 7:00 am

22510-asml-experience-center.jpgASML reported EUR2.78B in revenues with EUR2.08B in systems. 58% was for memory. EUV was EUR513M with 5 systems. Importantly orders were for EUR2.20B in systems at 64% memory and 5 EUV tools. This was likely better than expectations given the overall industry weakness. EPS of EUR1.60 was more or less in line with expectations. Guidance of roughly EUR3B in revenues for the December quarter is very good.

ASML suggested that 2019 was still an up year for then with H1 2019 looking like H2 2018. This suggests that the slow down has minimally impacted ASML.

Given the combination of lead times and the critical nature of EUV, most customers do not want get cancel or delay orders as they will fall behind.

Aside from the discussion of the 3400C we did not hear a lot more about EUV progress. We would like to hear more about their 500 watt source but we imagine they are saving that information and announcement for their analyst meeting.

We do think that ASML is being a bit optimistic about the number of layers in use for EUV. We have heard that TSMC is running about 4 layers of EUV at 7NM rather than the double digits ASML is talking about.

The fall off of GloFo has not impacted ASML’s ramp. We see no reason why ASML can’t or shouldn’t get to its goal of 30 tools in 2019.

While tools continue to ship, EUV use in HVM still has issues to work out in areas we have previously identified such as resist, pellicles, up time etc; etc;. Progress continues to be made and we see no show stoppers but we would caution that not all issues are fully under control.

We think the stock will see a nice reaction given a good result and better guide coupled with Lam’s better than expected report. We think ASML along with KLAC are good ways to play the EUV roll out as well as defensive and safer plays that are most immune to the current weakness and potential increasing weakness in the memory markets. Right now it looks like the weakness in the market is roughly one year in length comprised of H2 2018 and H1 2019. Lam was obviously hardest hit at 25% down in business. ASML’s impact was minimal.
Lam research put up a quarter that was down 25%, more or less as expected, but the positive news is that it could have been worse as industry fundamentals have significantly eroded since the last report.

Earnings and revenues were above the midpoint of guidance coming in at $3.36 and $2.331B versus street estimates of $3.21 and $2.304B. Revenue was more os less in line with expectations and EPS was juiced up a bit by a huge, 10M share, $1.7B, buyback in the quarter which used up all their remaining buy back. Without the buy back EPS would have been in line. We had suggested in previous notes that we expected companies to use their large cash hoards to do buy backs to mitigate the weakness.

OPEX was well managed to a lower number which added to performance along with new revenue recognition that kicked in during the quarter.

Perhaps the more important news was guidance for $2.5B in revenues for the December quarter which would be up, and thus “on a positive trajectory” as previously hoped. Some of uptick may be revenue recognition but the overall flat to up guidance is better than the expectation of Lam having to lower their numbers again (which obviously didn’t happen). While the company was clear that EVERY NAND customer was down and the industry was negative, they also focused on their performance being resistant to this overall down cycle.

Its also clear that we will not see a “V” shaped bottom in the current down cycle and we will not see a “sharp snap back” but rather the more normal “U” shaped bottom.

Lam tried to set itself apart from the overall semi equipment market suggesting that they were not experiencing the same amount of weakness even though they were down 25% Q over Q.

Memory dropped from the unsustainable 84% of business to a still high 77%. China was surprisingly strong at 25% helping to offset weakness from mainstream customers. The recently announced cut in CAPEX by Nanya, number 4 in memory, is more typical of what is occurring.

The stock was up huge in the after market as there was a giant sigh of relief that it wasn’t nearly as bad as it could have been….being down 25% is bad enough.

If we take out the buyback, results were just in line but in line is better than what the street had assumed. Lam is looking for an up H1 2019 but we think its still a bit early to get positive as signals seem to continue to be negative. Part of the question will be if Lam can buck the overall trend enough or at least better than average.

We think the stock may open up but likely fade a bit as investors realize its mainly relief and not proof of an up cycle.

“It could have been worse” is not a super compelling argument to go buy a stock but will help prevent more downside in the near term.

The thirst for infinite memory
Memory used to play a much smaller role in the semi ecosystem as it was largely confined to DRAM for use in PC’s to run the OS and applications. NAND has now replaced much of the rotating media as well as replacing optical disks, magnetic tape and photographic film as a storage medium. New faster, non volatile memory is on the horizon which could power another memory spike.

Memory hit an unsustainable peak of 84% of Lam’s business before falling. The historical norm of memory and logic/foundry being in closer balance was obviously upended.

Much of that was due to the conversion of 2D NAND to 3D NAND which is obviously a one time event. We are now past that spike in demand and back to a more normal production process flow.

Simply put, when we look back on the past few years of the strong up cycle we had a perfect storm of unusually high demand as most memory applications changed to silicon based memory coupled with a significant change in process technology requiring huge investments in the new process.

We are now at a new, more stable plateau of memory demand that while growing is not experiencing the “step function” growth seen in end use change. Additionally we are at a more stable production environment where any major NAND player is producing using 3D technology as 2D is essentially dead from a financial model.

While AI, VR and new applications will drive the TAM growth for memory we will not see the step function growth experienced in the past when other storage media was replaced in a very short period by NAND.

All this suggests is that memory growth while very good, will not be as “rocket-like” that we experienced over the previous years.

A “mix shift” away from dep/etch towards litho/metrology

We will also see a mix shift in demand for equipment companies products due to changes in process technology to keep up with Moore’s law.

A second factor underlying the unusually strong growth in the prior cycle for some equipment companies, and not others, was the fact that the long delay in EUV forced the industry into a “make do”, substitute, process technology of multi patterning.

Rather than the industry progressing on its normal path of better litho techniques to drive Moore’s law, it got side tracked into doing multiple deposition and etch steps as a substitute technology due to the unavailability of EUV.

Now with EUV starting to enter high volume manufacturing we can expect less multi patterning and thus less deposition and etch equipment and more lithography and lithography supporting equipment such as metrology and mask inspection.

Currently the industry leader (TSMC) is running a “hand full” of layers using EUV technology at 7NM. This is expected to enter more or less “full” EUV implementation at 5NM with a “low teens” number of layers processed with EUV.

To be perfectly clear, multiple patterning doesn’t go away entirely as it will still be needed for EUV but its higher than market rate growth is essentially stopped.

This means that in addition to a slowing memory spend, AMAT, LRCX, TEL and other dep/etch companies will get hit by a double whammy of slowing multi-patterning spend in the cyclical recovery.

ASML will obviously be a big beneficiary of the shift to EUV but also metrology/yield management companies such as KLAC, NANO etc;, to deal with the more difficult litho techniques.

Overall CAPEX spend for EUV will be lower as compared to multi patterning as EUV is, after all, a cost savings technology as well as a Moore’s law driver. While not a huge headwind for the semi equipment industry it is none the less an impediment to getting back to a higher growth rate.

More importantly for investors, it likely changes the companies to invest in and the valuation of those companies as the growth rates will be different in the coming up cycle as compared to the prior up cycle. While all companies will benefit, the relative winners will be different in the coming up cycle.

The “black swan” cloud over the recovery
Another complicating factor that is near impossible to predict but must be factored into investors minds is the potential of a trade war or other global macro event. In prior administrations, the likelihood of a macro disruption to the industry was so low as to be ignored. Now, the probability of a trade disruption to the very international semiconductor industry cannot be ignored.

While the odds are still low, the potential continues to rile the markets and has to be taken into account by companies in the industry for their planning.

This indirectly can slow growth the semi market as companies may be more conservative and cautious as to their growth plans. Companies may be slower to spend or start new projects.

So while all bets are off on a trade war, we can assume a bit of a wet blanket on enthusiastic growth.

Weather report- From Sunny & Warm to Cooler and Cloudy with a tornado watch

Overall we see the great growth factors which drove the industry over the past years cooling a bit in the next up cycle so we are looking for a slower recovery at least initially.

The long term for semiconductors is up and to the right as it has always been but with a little less gusto. While we obviously can’t predict the next product/application that causes a dislocation in demand but those new things that are out there, AI, VR, AR, autonomous vehicles etc; are longer term in nature and part of a strong foundation of growth rather than an upward spike.

On the supply side we have China coming on as a major new source of supply that will be incremental to existing supplies in Taiwan, Korea and the US. Predicted new supply from China will likely easily offset new demand as discussed above and likely at competitive pricing keeping revenue growth lower.

China supply will be increasing over the next few years as we come out of the current down cycle which could act as another headwind or impediment to a return to faster growth. However they are still not a factor at the leading edge so impact will be somewhat limited.

The Stocks
We still see no reason to jump back into the stocks as the momentum continues to be negative. Quarterly earnings reports will not be all that positive.

We don’t think semi equipment companies will be calling for a recovery in one quarter again after being burned. Analysts are still capitulating, after the fact, and dropping like flies.

Not all companies have capitulated. That capitulation may be the indication of a bottom. Stock buy backs and large cash hoards will soften the impact but not zero it out. Everyone is still making lots of money, just a little less of it.

Right now, our best guess is a “U” shaped down cycle with a bottom in H1 2019. We see a slower return to growth out of the bottom as the high growth factors have cooled a bit. We would also remind investors that Q1 is the seasonally weakest time for the chip industry so we don’t expect it to be the catalyst of a recovery.

The stocks could be off up to 50% from their highs. AMAT seems on its way to $30, LRCX feels like its on its way to $125, ASML to $160 and KLAC on its way to $90. This feels like a fairly normal cyclical correction in stock prices. As usual, smaller cap names and sub-suppliers are harder hit as they are on the end of the whip.

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