AI and local production plans drive the semiconductor industry
Artificial intelligence (AI) is currently the dominant topic in the technology sector. New, fast data centres require enormous investments. Microsoft and OpenAI recently announced that they will invest USD 100 billion in an AI data centre project. This benefits NVIDIA in particular with its high-performance processors (GPUs), but also the entire semiconductor industry. Fast memory chips (so-called HBM, High Bandwidth Memory) are being developed, which will benefit memory chip manufacturers such as Samsung.
By Hagen Ernst, Deputy Head of Research and Portfolio Management at DJE Kapital AG
The market for semiconductor equipment and machines for the production of AI chips appears to be particularly interesting. In addition to AI, several factors such as increasing capital intensity (semiconductor production is becoming ever more complex) and the establishment of local production facilities (to reduce dependence on Taiwan) are coming together, which could lead to above-average structural growth.
New production capacities and strategic expansions
Despite the current AI hype, 2023 was a difficult year for the semiconductor industry. According to the Semiconductor Industry Association (SIA), the market for wafer fab equipment (WFE) shrank by eight per cent, but held up better than the overall semiconductor market, which slumped by 16 per cent (see table). 2024 is likely to be another year of transition. We should be close to the trough and then see an upturn from the second half of the year. The SIA is forecasting growth of two per cent this year and eight per cent next year. Several factors are coming together here: New production capacities for AI chips are needed. In addition, the recovery in the memory chip segment after years of low investment by memory chip manufacturers is likely to lead to strong demand, particularly for capacity expansion for fast DRAM memory chips (HBM). Furthermore, new local chip factories are being planned worldwide in order to reduce dependence on Taiwan, where a large proportion of semiconductors are manufactured. High subsidies are being used to attract leading semiconductor manufacturers such as TSMC and Samsung to set up sites in their own country. With the "Chip Act", the USA has adopted a USD 52 billion programme and Europe a USD 43 billion programme to establish local production facilities. Thanks to generous subsidies, Samsung, for example, plans to invest USD 44 billion in a new plant in Texas (almost triple the original plan) and TSMC up to USD 40 billion in a new plant in Arizona. In Germany, a US semiconductor manufacturer is investing more than 30 billion euros, including 9.9 billion euros in state subsidies, in Magdeburg. The establishment of new local production capacities should therefore lead to additional demand for semiconductor production machines from next year: Once the decision has been made to build a new factory, it must also subsequently be equipped with machines. Against this backdrop, the SIA's growth forecast of eight per cent seems rather too conservative, especially as the downturn in 2023 was exceptionally severe and growth in the upswing has always been significantly higher to date: +14 per cent in 2016 and +16 per cent in 2020 in the last two cycles.
Sales development in the semiconductor market
Source: Semiconductor Industry Association (SIA) as at Q1/2024.
Dynamic growth despite technological challenges
In a semiconductor market that is already growing at an above-average rate, the equipment sector is growing even faster. According to SIA, it grew by an average of eleven per cent between 2014 and 2023, while the semiconductor market only grew by four per cent per year. Ever smaller structures (two nanometres are already possible at TSMC today) have pushed semiconductor production to its physical limits. Last but not least, the exposure of the circuits (lithography) has become extremely complex. Extreme ultraviolet radiation (EUV) with a wavelength of just 13.5nm is required. A machine of this type costs well over USD 100 million. The increasingly complex manufacturing process has also meant that semiconductor production has become more and more capital-intensive. Only a few companies, such as Samsung, still have their own production facilities. Most chip companies, including NVIDIA, have now outsourced their production. In addition to increasingly capital-intensive production, the establishment of new local capacities in the USA and Europe is likely to lead to structurally higher growth.
A few large suppliers dominate the market
The market is now highly consolidated and is essentially centred on five major providers. With a market capitalisation of 350 billion euros, ASML is now the largest player. The Dutch have built up one of the few European flagship companies in the technology sector. With a market share of over 80 per cent, ASML has a near monopoly in the field of lithography. The company has benefited from above-average growth in recent years (an average of 15 per cent p.a. over the last five years), as the conversion to EUV is the most technically demanding process within semiconductor production. ASML therefore currently enjoys a premium over the sector. The switch to EUV has now taken place and the new generation of machines is no longer so extremely demanding, which could mean that other processes in back-end production, for example packaging, i.e. the insertion of a housing and electrical contacting, could take centre stage and ASML could therefore tend to grow in step with the sector again in future. Tokyo Electron is one of the companies represented in the two important processes of wafer coating by means of etching and chemical vapour deposition (CVD). Tokyo Electron is benefiting from the current persistent weakness of the yen, but already has a high valuation premium (P/E ratio 28 for 2025 vs. peer 24). For all providers in this sector, the partly recurring service business has led to a certain degree of profit stability in the crisis year 2023, although the business remains volatile and sensitive to the economy.
Long-term investment opportunities and the difficult question of exit
All shares have already performed well over the past year (and in some cases almost doubled, e.g. Tokyo Electron). Nevertheless, there could be further upside potential. For one thing, we are only at the beginning of an upswing, which usually lasts three years. Secondly, the market estimates appear rather conservative. For example, the SIA only expects growth of eight per cent in 2025, which is significantly below the usual growth rates in upswing phases of the past. Some special factors such as AI and the establishment of local production facilities even suggest that the upturn will be stronger this time and possibly last longer. At the same time, it is difficult to determine the exact timing of the exit. Downturn phases are often anticipated very early on (around 18 months in advance), which would mean that the upturn that is now beginning would usually end in three years, i.e. in mid-2027. Ultimately, the exact timing is very difficult and investments in good companies should have a long-term horizon. In the long term, however, all semiconductor equipment suppliers should participate in structural growth.
Conclusion: Growth drivers AI and local production support the semiconductor market
Although semiconductor equipment stocks have already risen sharply, they could still have further upside potential as we are only at the beginning of the upswing, which usually lasts three years. Moreover, this time the upturn could be stronger and possibly last longer, while current market estimates still assume below-average growth. At least some special factors such as AI and the global expansion of local chip factories indicate this. However, shares are very volatile, and investors should therefore keep a close eye on the sector.
Note: Marketing advertisement - All information published here is for your information only and does not constitute investment advice or any other recommendation. The statements contained in this document reflect the current assessment of DJE Kapital AG. These may change at any time without prior notice. All statements made have been made with due care in accordance with the state of knowledge at the time of preparation. However, no guarantee and no liability can be assumed for the correctness and completeness.