A global chip shortage has chipmakers scrambling. Semiconductor fabricators are expanding their manufacturing lines to boost supply, and new chip designs necessitate more advanced equipment. As a result, the next year or two looks incredibly promising for the equipment makers that provide the machinery needed to construct the basic building blocks of today's technology.
It's a good time to be a semiconductor investor.
Five top semiconductor equipment stocks
Building a semiconductor is an incredibly complex (and expensive) process often involving hundreds of steps. There is a small bit of product loss at each step in the process, so the best manufacturers are the ones who can really minimize loss along the way. Equipment designers and manufacturers plow hundreds of millions of dollars into physics, chemistry, and engineering research to refine this process as well as meet the demands of their customers -- think name brands like Intel or Samsung.
Image source: Getty Images.
But behind the scenes are the incredibly profitable researchers making construction of electronic devices possible in the first place. Here are the five largest names in chip fab equipment.
|
Company |
Market Cap |
TTM Revenue |
TTM P/E Ratio |
|---|---|---|---|
|
ASML Holdings (ASML +3.42%) |
$280 billion |
$18.6 billion |
53 |
|
Applied Materials (AMAT +1.76%) |
$126 billion |
$18.2 billion |
33 |
|
Lam Research (LRCX +2.50%) |
$91 billion |
$13.3 billion |
27 |
|
Tokyo Electron (TOEL.Y +0.15%) |
$71 billion |
$12.0 billion |
35 |
|
KLA Corp. (KLAC +3.26%) |
$52 billion |
$6.1 billion |
38 |
Data sources: YCharts and company investor relations websites. TTM = trailing 12 months. P/E = price-to-earnings.
1. ASML Holdings
The biggest name in this industry (both by market cap and sales) is ASML. Manufacturing chips involves a process known as lithography in which patterns of electrically conductive metals are printed onto silicon. ASML is the largest maker of this lithography equipment, as well as other systems and software that make chip fabrication possible.
ASML (as well as its peers also discussed here) has two components to its revenue: The sale of the equipment itself, and the services associated with that equipment. In recent quarters, revenue has been rising sharply as the company's customers purchase new equipment to meet demands. But ASML's service segment is primarily recurring revenue based on the number of machines it has in operation worldwide (known as the installed base, kind of like how Apple might reveal its "installed base" of iPhones in use around the globe).
ASML is rolling out new software to its installed base to help fabs increase output and unlock new lithography patterns for more advanced chips. As a result, revenue increased by 79% year over year last quarter, and earnings by a whopping 240%, as higher usage of equipment helps the company reach a more profitable scale.
With companies like Intel and Taiwan Semiconductor Manufacturing purchasing new machinery and in some cases getting government backing to do so, ASML looks primed for even higher sales in the year ahead.
2. Applied Materials
Applied Materials (AMAT) also provides lithography equipment, as well as other machinery used in fabs like gas pumps and inspection machines. AMAT also has a business segment dedicated to the ultra-high definition OLED display manufacturing industry, providing another area of exposure to some of the highest-growth areas of the tech world.
Service revenue also features prominently here at just under one-quarter of sales. Software is again the key as the company helps its customers increase the output and utility of their fab equipment.
AMAT is not growing nearly as fast as ASML is. Revenue increased "only" 24% year over year in its latest quarter, and the company is anticipating a 36% rise during the next one. However, it too is enjoying an even faster pace of earnings growth as its customers buy new equipment and complementary software.
3. Lam Research
Lam competes directly with AMAT, providing many of the same systems and processes minus the OLED screen segment. Lam specializes in equipment that helps fabs print the many layers of transistors in some of the most advanced chips. However, the company does derive more of its revenue from services, clocking in at just over one-third of sales. Lam has thus been one of the more stable equipment manufacturers over time owing to this high rate of services income.
Lam is also returning gobs of excess cash to shareholders, primarily via stock repurchases. In fact, factoring for this high rate of cash returned (dividends plus share repurchases totaled $1.28 billion during the last quarter alone, or 33% of revenue) makes Lam the best income investor stock on this list.
4. Tokyo Electron
Tokyo Electron also provides various systems that help prepare and print layers of metal on silicon. And like AMAT, Tokyo Electron also has a hand in the making of high-performance screens for devices. It isn't growing as fast as AMAT or Lam, but nonetheless is expanding at a respectable rate -- 19% so far during its current fiscal year.
China, in particular, is investing heavily to ramp up its domestic production of chips, and this could be a key ingredient in Tokyo Electron's growth going forward. China was its largest end market in the last year, comprising nearly one-quarter of total revenue. Taiwan, also a primary supplier for China's rapidly growing demand for semiconductors, made up another 16% of Tokyo Electron's sales.
5. KLA Corp.
By far the smallest company here, KLA's equipment helps with the fabrication of wafers (the substrate circuits are built on) to packaging (the final step in the manufacturing process in which a chip is encased in a protective layer), as well as electronic device screens. KLA is also the slowest-growing company on this list (revenue was up 9% last quarter), but sales and earnings are pointing higher as the global chip shortage deepens.
Despite the tame financial results compared to its peers, KLA is worth a look for income investors. The company's dividend currently yields 1.1% a year, and share repurchases double the effective yield on return of cash to shareholders.
Mind the upcycle
When investing in semiconductor companies, it's important to bear in mind that these are cyclical businesses. Sales are expanding at a fast clip right now, but when the global chip shortage eventually eases, the double-digit percentage advance will also cool off. This can create some wild ups and downs in share price. Be ready for these downturns and have some cash handy to buy the dips.
For now, though, equipment enabling the manufacture of chips is a high-growth industry. With no signs of slowing down this year, these semiconductor equipment companies are worth keeping tabs on.
