Inflation, war, and surging interest rates have pummeled the market of late, especially tech stocks. Netflix (NFLX 0.33%) earnings may have shown the consumer pulling back on certain tech purchases -- at least those that are highly discretionary. With investors in a sour mood, every bad earnings report from any prominent company is leading to talk of a recession.
But don't tell that to the semiconductor industry. Despite the dim view of many investors, semiconductor sales are booming right now. Not only that, but based on recent industry commentary, the strength should continue for the next couple of years, despite what the overall economy might do.
The megatrend is overwhelming the cycle
Over the past week, several bellwether semiconductor production companies have reported earnings, including Taiwan Semiconductor Manufacturing (TSM 0.57%) and ASML Holdings (ASML 1.38%). Taiwan Semiconductor Manufacturing is the world's leading third-party foundry, with more than 50% market share. Meanwhile, key toolmaker ASML is the leader in lithography equipment, which beams extremely thin lasers that print transistor patterns on wafers. ASML also has a monopoly on key extreme ultraviolet (EUV) technology needed for leading-edge chips.
Both companies beat analyst expectations last quarter and pointed to incredibly strong demand going forward. Just how strong? Taiwan Semi said it was now worried about having enough capacity to meet demand next year, and that's on top of 30% growth projected for this year. And this year's growth will come on top of 18.5% growth in 2021 and 25.2% growth in 2020.
With that much growth over three years, investors have now soured on the entire sector. TSM is down some 31% from its 52-week highs. With inflation running hot and the Federal Reserve raising interest rates, some think a violent semiconductor downturn like those seen in the past is around the corner.
Here's why that probably won't happen.
The semiconductor industry is accelerating
One big revelation from TSM's earnings call was that management predicts the semiconductor industry (ex-memory) will accelerate to a high-single-digit average rate over the next five years. If that doesn't sound impressive, the industry grew at just a 4% average annualized growth rate over the past decade.
That difference in growth rates, compounded over five or 10 years can lead to a big difference in industry size, which may account for the discrepancy between the market's perception and current guidance. If the investing community thinks that the current strong market will mean-revert to the prior growth rate, they could be underestimating demand.
ASML corroborates the story
On Wednesday, ASML followed TSM with very bullish commentary of its own. In fact, ASML management said it was now trying to increase its capacity in a big way, and it may not even be able to fulfill all its demand even then. Originally, ASML projected capacity of 375 deep ultraviolet (DUV) machines and 70 EUV machines by 2025. Now, the company is trying to pull out all the stops with its suppliers to reach 600 million DUV machines, 90 0.33 NA EUV machines, and 20 advanced 0.55 NA EUV machines by that time.
Could ASML be too optimistic about demand, given the many economic headwinds, real or perceived? Currently, ASML says it is able to fulfill only 60% of total demand, and if people want a DUV machine today, they won't be able to get it until the end of next year -- 18 months from now. When challenged on whether management was being too optimistic, given investors' concern over a slowdown next year, CEO Peter Wennink said:
[T]he demand for next year is 600 units. So you need to lose 35% to 40% of your demand. And then you hit our capacity, our maximum capacity.
So, unless semiconductor equipment demand plummets 35%-40% below expectations, it looks like the industry will keep growing.
How this is possible?
Some may ask why how the huge $555 billion semiconductor industry can accelerate at this time. While technology is a long-term growth trend, two main factors appear to be turbocharging the industry at the same time. First, the need for leading-edge chips to deliver high-performance, energy-efficient computing, serving artificial intelligence applications, is taking off in a big way. In addition, the Internet of Things, a broad term for more automated factories, appliances, and automobiles, is requiring a tsunami of demand for more mature, lagging-edge chips far beyond current capacity.
These two big megatrends are happening all at once -- not to mention the uptake of 5G phones and high-end PCs. Coming on the heels of tepid capacity investment in 2018-2020 because of the U.S.-China trade war and then the onset of COVID, industry capacity is far behind demand.
So for those who think these boom times for semis will eventually bust next year, they may have to wait much longer.