For more than ten years, semiconductor stocks have been out of favor among investors, due to the stigma of the dot.com that marked the high tech boom, and the prolonged stagnation in capital spending by the likes of Intel (INTC) and Taiwan Semiconductors (TSM), Advanced Micro Device (AMD) and Nvidia (NVDA).
Semiconductor equipment leaders like Applied Materials (AMAT) have been trading 45 percent below their 2000 high (adjusted for a 2002 stock split), Teradyne (TER) near 80 percent, Novellus Systems (NVLS) 40 percent, and KLA-Tencor (KLAC) 35 percent; and they all command low PEs-single to low teen digits.
Kulicke and Sofa Industries (KLIC)
Lam Research (LRCX)
This situation seems to be changing lately, as the stigma of the dot.com era fades from investor memory, and chip makers open their wallet (Intel and Taiwan Semiconductor have announced capital expansion recently), the time is ripe to take another look at the sector. According to a Gartner report, semiconductor equipment spending is expected grow by 19.2 percent in 2012, reaching $35.2 billion. Applied Materials recently noted that it is globally tracking 18 new fab expansion projects by semiconductor manufacturing firms. Intel plans to increase capital spending by 73% to $9 billion in 2011, while Taiwan Semiconductor plans to up spending by 30 percent to $7.8 billion.
Industry fundamentals are clearly improving for the following reasons:
1. Tight capacity. The capacity utilization rate among semiconductor producers is over 90%, a level that typically results in large increases in capital spending.
2. Rising orders. Semiconductor equipment orders rose by 4.7 percent in February of 2011, and billings rose for a third month in a row.
3. A replacement cycle and new manufacturing technology. Most the semiconductor making equipment is ten years old, too long for an industry in the forefront of innovation. A move toward 22-nanometer technology will drive industry-wide growth.
4. New product-cycle. The IT industry is in the middle of a new revolution propelled by handheld devices like smartphones and iPads that require a new generation of semiconductors, especially in flash memory devices, that must be produced with new equipment. Companies like AMAT that have branched out into solar energy may further be benefited by the surge in alternative energy technologies.
5. Binding entry barriers make the industry an oligopoly that allows major players to maintain pricing power.
The bottom line: Semiconductor equipment stocks may not reach their old bubble values any time soon, but they may reward handsomely long-term investors.