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Morningstar | Tokyo Electron Set to Outgrow the Equipment Market Again in Fiscal 2019; Shares Fairly Valued. See Updated Analyst Note from 27 Jul 2018

Tokyo Electron Ltd, or TEL, reported strong fiscal first-quarter results that exceeded our expectations, led by strong 3D NAND flash and DRAM demand for TEL's etch and deposition equipment. Similar to Lam Research and Applied Materials, TEL has benefited from the ongoing transition from planar NAND to 3D NAND and advanced DRAM technologies at customers such as Samsung, Micron, and SK Hynix. Management reiterated their fiscal 2019 top-line growth rate of 24%, which we view as plausible given the current semiconductor market environment. We are maintaining our fair value estimate of JPY 18,500 per share. Shares of narrow-moat TEL appear fairly valued at current levels.

First-quarter revenue was up 25% year over year and down 17% sequentially to 296 billion yen. NAND equipment sales rose 59% year over year to 108 billion yen, thanks to 3D NAND investments from the aforementioned memory chipmakers. Foundry revenue fell 68% year over year to 9 billion yen, which we attribute to a pause in equipment spending after recent investment for 7-nanometer processes. We remind investors foundry purchases can be lumpy, and we expect the second half of calendar 2018 to see stronger investments from the likes of TSMC based on recent commentary from TEL's peers. TEL's gross margins fell 170 basis points sequentially to 41.4% due to lower equipment volume relative to the fiscal fourth-quarter.

Sales for the fiscal second quarter are expected to rise substantially, as implied by the first-half revenue guidance of 690 billion yen for fiscal 2019. Nevertheless, we think second-half sales could be modestly lower than management's forecast of 710 billion yen, as peers have noted delays in equipment shipments, particularly at memory customers (we surmise Samsung). In the logic and foundry space, the firm now expects roughly stable spending this year versus calendar 2017, an increase from its prior view of down 10%, thanks to healthy 10-nm and 7-nm spending by TSMC, Samsung, and Intel.

For calendar 2018, memory will remain the key driver of wafer equipment spending, with TEL foreseeing 60% growth in DRAM off a lower base last year and 5% growth in NAND off elevated levels in recent years. In DRAM, 70% of investment is to be for new factories, which supports our view that we will reach a period of oversupply sometime in late 2019 to early 2020 that could cause material pricing headwinds. Greater content for both DRAM and NAND in data centers for cloud workloads (especially artificial intelligence) should soak up much of the supply coming online, but we nonetheless are wary of potential oversupply signs that would also curb future capacity investment. Meanwhile, NAND demand should remain healthy enough to digest new supply from a greater number of chipmakers relative to DRAM, thanks to growth in SSD demand for data centers and PCs.