On March 17 and 23, Lam Research (LRCX) and Applied Materials (AMAT), respectively, pulled their outlook for their next quarter. Frankly I was flabbergasted that during their earnings calls executives from these companies downplayed the effect of COVID-19, particularly AMAT, whose earnings call was a month after LRCX and COVID-19 was becoming more rampant.
For example, I wrote in a Feb. 13, 2020, Seeking Alpha article entitled “Applied Materials Downplays Coronavirus In Guidance,” I noted in my summary bullets:
- Applied Materials recently announced fiscal Q1 earnings, presenting an upbeat guidance based on interpreting the coronavirus epidemic as temporary and lasting one quarter.
- Uncertainty with the epidemic and a spike in cases in China based on new testing methods suggest the company’s guidance needs close monitoring.
- A further headwind facing Applied Materials is flattish logic/foundry capex spend and a double digit drop in memory spend in 2020.
Not leaving LRCX off the hook, I wrote in a March 5, 2020, Seeking Alpha article entitled “Lam Research Investor Day: Execution Easier Said Than Done:”
“Lam expectations are based on WFE spending associated with increased revenues, and on technology evolution. Lam expects the WFE market to grow 20%-plus in 2020. I disagree, and readers can look over my analysis on Jan. 29, 2020, Seeking Alpha article entitled “Lam Research: Revenues Could Beat Because Of Revenue Pull-Ins.” This analysis is proving more probable with the CORVID-19 virus.”
My 2020 Outlook for Semiconductors and Equipment
I presented my forecast for the semiconductor equipment market in a Jan. 29, 2020, Seeking Alpha article entitled “Lam Research: Revenues Could Beat Because Of Revenue Pull-Ins.” I forecast that because of significant $4 billion in equipment pull-ins in Q4 from sales in Asia, I was reducing my semiconductor wafer front-end (WFE) equipment revenue growth from an earlier +5% to 0% in 2020. Now, based on COVID-19, I’m further reducing revenue growth to -6.9%.
These sell-side analysts seem to forget, or perhaps they never know, that there’s an intimate correlation between semiconductor sales, equipment sales, and GDP. Chart 1 illustrates that relationship. Except for the differences in amplitudes peaks and valleys, these inflection points occur nearly simultaneously at any given time.
Factors Influencing My Analysis
Drop in GDP
Chart 2 also shows the cyclical nature of semiconductors and semiconductor equipment. In principle, semiconductor manufacturers increase production to meet customer demand. If demand increases, manufacturers will make capacity purchases of processing equipment to make more chips. This is why there is strong correlation between semiconductor revenue changes (blue line) and semiconductor equipment (red line).
GDP (black line), which measures the value of economic activity within a country, is often a factor in halting the increases in semi and semicap revenues. GDP is important because it gives information about how an economy is performing. The growth rate of GDP is often used as an indicator of the general health of the economy.
Thus, if a country has healthy economy (upward slope of black line), we often see an upward slope in semi and semicap revenues. The converse also is true. If the economy is doing well, individuals have money to make purchases of products using chips – smartphones, cars, TVs, etc.
2020 is now bringing COVID-19 and along with it a forecast of GDP growth of -1.2%. The forecast of -1.2% is based on a survey in early April of over 50 economists in North America, Europe and Asia, which showed the global economy would contract 1.2% this year with forecasts in a range of -6.0% to +0.7%.
Drop in Capex Spending
According to Table 1, expected capex spend for these top five companies will decrease 12.1% in 2020, according to our report entitled “Global Semiconductor Equipment: Markets, Market Shares, Market Forecasts.”
An additional concern I have is leading semiconductor companies borrowing money and halting stock repurchases, which could be indicative of concerns that COVID-19 could force them to cut capex further. For example, Micron Technology (MU) announced plans on March 14 to draw $2.5B under its revolving credit facility to increase cash position and preserve financial flexibility in light of current uncertainty in the global markets resulting from the COVID-19 outbreak.
On March 24, 2020, Intel Corporation (INTC) announced that it’s suspending stock repurchases in light of the COVID-19 pandemic. And on March 25 Intel issued $8bn of notes for general corporate purposes, including, but not limited to, the refinancing of outstanding debt, funding for working capital, and capital expenditures in a six-part trade.
All signs are pointing to a drop in semiconductor and semiconductor equipment revenues in 2020 due to the financial fallout of COVID-19. We all know the damage the virus has caused in human lives and the financial fallout that followed.
Because of the economic fallout of China Trade, most countries in Asia and Europe were pushed to the brink of recession in 2019. COVID-19 followed in Q1 2020, further weakening these countries and the U.S. as well.
Table 2 compares GDP, semiconductor and semiconductor equipment revenues for 2008-2009 and 2019-2020. A striking observation in the comparison of the two crises is the similarity of YoY changes in the year up to and including the year that GDP dropped in 2009 and forecast to drop in 2020. That’s despite the difference in origins of the recession.
The impact of this drop in revenues will primarily impact processing equipment companies AMAT and LRCX. ASML (ASML) is another processing company that currently does not see the impact of COVID-19 beyond Q1, but the company announced in a press release on March 30 it could affect Q2. The company noted:
“Due to the uncertainties regarding COVID-19, ASML has decided not to execute any share buybacks in Q2 2020. This decision follows the pause in the execution of the program in the first quarter, after having already performed share buybacks under the new program for an amount of approximately €507 million.”
As I reported in a March 25, 2020, Seeking Alpha article entitled “KLA: Weathering COVID-19 Headwinds Better Than Any Peer In 2020,” KLA’s (KLAC) metrology/inspection equipment is very different from processing equipment such as lithography, etch, or deposition sold by peers.
KLA’s metrology/inspection equipment sales fare better during technology purchases vs. capacity purchases of equipment to make more of the same chip. With the slowdown in global economies in 2020, there will be minimal capacity purchases but major technology purchases for the next processing node. KLA will benefit, as well as ASML for its EUV systems, but they represented only 31% of total revenues in 2019.
This free article presents my analysis of this semiconductor equipment sector. A more detailed analysis is available on my Marketplace newsletter site Semiconductor Deep Dive. You can learn more about it here and start a risk free 2 week trial now.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.