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Morningstar | Sharp Sell-Off in Semiconductor Stocks Creates Attractive Entry Points for Wide-Moat WFE Firms

On Sept. 6, a flurry of news items sent semiconductor stocks lower as investors appeared to grow wary as the current upswing gets long in the tooth. Shares of Micron and KLA-Tencor were two of the hardest hit names, down 10% each. Both firms attended Citi’s 2018 Global Technology Conference, with management providing updates to their respective company’s prospects. Micron’s CFO David Zinsner noted NAND pricing declined in the third quarter, which was to be expected, in our view. Meanwhile, KLA’s CFO Bren Higgins reiterated that the September quarter would be the trough for 2018, while adding the December quarter rebound would be a little less than previously expected. We note there have been delayed capacity expansion plans cited by numerous industry participants (including Applied Materials in mid-August). All in, we believe the market overreacted to the commentary from these CFOs, and the sell-off has created appealing opportunities in our view. Within wafer fabrication equipment, wide-moat KLA-Tencor and wide-moat Applied Materials are both trading at attractive discounts to our fair value estimates of $128 and $49 per share, respectively. No-moat Micron, however, continues to trade at a premium to our unchanged $40 fair value, as we do not foresee the current favorable supply/demand dynamics persisting beyond a few more quarters.

On the same day, Digitimes reported that “Samsung Electronics and SK Hynix both intend to defer their capacity expansion plans, as a slowdown in customer demand will be dragging down DRAM and NAND flash memory prices through the first half of 2019, according to industry sources.” We note this sentiment is consistent with our view on memory prices and what management at WFE firms have been alluding to in deferred expansion plans.

Despite these well-chronicled memory-related equipment pushouts, we remain very positive on the long-term prospects for the WFE space. Given increasing complexity across logic, foundry, and memory structures, we foresee a sharp rise in process diagnostic and control intensity that will significantly benefit the likes of KLA. We foresee another healthy year of equipment spending in calendar 2019 thanks to material spending for advanced process technologies, particularly in logic and foundry, and see near-term headwinds as a buying opportunity.