What happened
Shares of semiconductor capital equipment makers ASML Holdings (ASML +3.62%), Lam Research (LRCX +2.29%), and Applied Materials (AMAT +1.34%) were down in August, falling 12.7%, 12.5%, and 11.2%, respectively, according to data from S&P Global Market Intelligence.
Even though Applied Materials reported strong earnings and gave a strong outlook during the month, it wasn't enough to stave off fears over a potential economic downturn. Since these three stocks each rallied in July, Federal Reserve Chair Jay Powell's comments at Jackson Hole, Wyoming, were enough to send them in reverse at the end of August.
NASDAQ: AMAT
Key Data Points
So what
Applied Materials reported its fiscal third-quarter results on Aug. 18, beating analyst expectations for both revenue and earnings per share, while also guiding for strong sequential growth. Interestingly, while investors seem to be concerned about demand, Applied management said its demand is still above its ability to supply, and that the company's backlog continues to grow.
Like Applied, both Lam Research and ASML reported better-than-expected results in July. In that light, one might be wondering what the problem was in August.
Clearly, investors don't believe the good times will last. The semiconductor equipment industry has seen three consecutive years of growth, and history indicates a downturn could happen after so many good years. And with recession talk in the air as the Fed raises rates, most expect semiconductor equipment sales to go into a downturn of some magnitude.
There are early indications that the memory market is in fact entering a recession. During the month, all the major memory chipmakers pointed to lower capital investments in 2023, as there is currently a glut of memory chips.
On the other hand, memory investment is the minority of total semiconductor capital expenditures today, with foundry and logic segments the majority. And currently, foundry and logic investment still looks strong.
That's because of intense competition among the world's leading foundries for leading-edge capabilities, and developed nations now subsidizing investment in manufacturing on their own shores. Meanwhile, there are still actually semiconductor shortages on trailing-edge nodes, so new capacity is still being added for lagging-edge chips for auto and Industrial Internet of Things applications.
Still, investors are skeptical chip sales will hold up if there is a recession, and those fears came to the fore late in the month with the Fed's meeting in Jackson Hole. That's where Fed Chair Jay Powell indicated the Federal Reserve would probably keep interest rates high until there is clear evidence inflation is coming down.
Investors will have to see what the Fed does in response to incoming inflation data, but the speech seemed to stoke recession fears. The entire stock market took a leg down on the day of Powell's speech, but technology and cyclical stocks such as those of semiconductor companies were hit particularly hard.
Now what
These semicap equipment vendors have each said they would be more resilient in a downturn than in the past. That may actually be true. In fiscal 2019, when the last downturn occurred, Applied saw revenue decline 12.6% and operating income decline 25.4%.
However, these companies are more skewed toward foundry and logic segments today. Back in 2018, before the last downturn, Applied received only 36% of sales from foundry and logic customers and the other 64% from memory customers. However, last quarter, those ratios were practically flipped, with Applied generating 66% of sales from foundry and logic customers, with just 34% of sales from memory customers.
Lam Research gets a greater proportion of sales from memory customers, but its ratio of sales to memory customers is also lower today, at about 60%, versus 78% in 2018. Therefore, a memory downturn may not affect these companies' results as much as in the prior downturn.
Investors really won't know the answer until the economy either enters (or avoids) a recession. Still, with Applied and Lam trading at just 12 and 13 times earnings, respectively, it appears a downturn is priced in to a large degree, especially since semiconductor investment will grow over the long term.
ASML trades at a higher 33 times earnings, but it always trades at a higher multiple than peers due to its monopoly on extreme ultraviolet (EUV) technology, which is essential to producing the world's most leading-edge chips.
Thus, longer-term investors may wish to look at these beaten-down tech leaders after a rough month, as they look like true bargains; however, don't expect it to be a smooth ride over the next few months or quarters.
