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Morningstar | Tokyo Electron Lowers Full-Year Guidance Amid Near-Term Headwinds; Shares Nonetheless Undervalued. See Updated Analyst Note from 31 Oct 2018

Tokyo Electron reported strong fiscal second-quarter results that exceeded our expectations, led by solid demand for the firm's etch and deposition equipment from logic, foundry, and DRAM customers. Similar to peers, however, the firm experienced a slowdown in NAND-related equipment sales. Due to well-documented delays of capital investment by memory customers and display manufacturers for small/medium panels for mobile, management revised its fiscal 2019 top-line growth target to 13% down from 24%. We had previously anticipated a slowdown in 2019, and it appears this is occurring sooner than we had contemplated in our model. Our longer-term outlook for narrow-moat Tokyo Electron remains intact, and we think shares look attractive relative to our unchanged fair value estimate of JPY 18,500 following the recent sell-off across semiconductors.

Second-quarter revenue was up 41% year over year, and up 34% sequentially to 395.5 billion yen. DRAM sales rose 67% year-over-year and 30% sequentially, thanks to broad-based spending from Samsung, SK Hynix, and Micron. We attribute these tool purchases to technology migrations for advanced DRAM nodes, as each firm has been very careful in avoiding excess supply conditions to mitigate pricing declines. Logic revenue from the likes of Intel was up 75% sequentially to 65.4 billion yen, which we view as consistent with Intel’s ramp of its 10-nanometer process. Foundry revenue rose 92% year-over-year to 31.3 billion yen, which we attribute to 7-nm equipment spending from TSMC and Samsung. Tokyo Electron’s gross margins fell 50 basis points sequentially to 40.9% because of a less favorable product mix.

Management expects sales for fiscal 2019 to be 1,280 billion yen, which implies 13% growth over fiscal 2018, but also a slowdown in revenue growth during the second half of fiscal 2019. The primary driver of the second half weakness is an expected decline in memory and display spending. We attribute the recent sell-off across semiconductor stocks to an assortment of factors including macro-related concerns such as tariffs, the escalating trade war between the U.S. and China, inventory builds, and memory price declines. However, the end-market diversity beyond PC and smartphones for semis, which includes the shift to the public cloud, rise in automotive chip content, investments in 5G, and Artificial Intelligence should collectively allow for less cyclical behavior for overall wafer fab equipment patterns, in our view. We note memory suppliers are better equipped to navigate “downturns” with greater cash cushions and profitability levels from the recent memory upswing, thanks to more rational behavior from a supply/demand standpoint. Consequently, short-term delays in equipment spending by Samsung and Micron shouldn’t last nearly as long as past downturns, which bodes well for Tokyo Electron and its peers.