Japan's 'Seven Samurai' : Tokyo Electron, Entering a Recovery Phase Soon

Tokyo Electron is the biggest vendor of semiconductor fabrication tools in Japan, holds a dominant share of Dielectric Etch, a 90% share of global resist coating systems, and is the world's fourth largest supplier of semiconductor production equipment (SPE) and a leading supplier of flat-panel display production equipment (FPDE). It operates primarily in the etch, deposition, and clean segments, which involve adding and removing materials to and from semiconductor wafers. Customers include leading-edge logic, foundry, and memory chipmakers such as Intel, TSMC, Micron, and Samsung.

As of June 25th, the company's stock price has risen by 36.85 % this year, significantly outperforming the Nikkei index. It is expected to enter a recovery phase soon due to the growing demand for semiconductors and the expansion of the 5G market.

As for the business segment, the majority of TEL's revenue comes from semiconductor manufacturing equipment, accounting for 97.56% of total revenue. The remaining revenue from flat panel display (FPD) manufacturing equipment and other business segments accounts for only about 4% of total revenue.

In mid-May, Tokyo Electron (TEL) released its performance for the previous fiscal year (April 2023-March 2024) and the fourth quarter (January-March 2024). Overall, TEL's performance for the current fiscal year has been relatively weak compared to the previous two years, but it is largely in line with the conservative guidance given by the company at the beginning of the year.

Compared to past performance, the market seems to be more concerned about the company's future guidance. At the earnings announcement press conference, the CEO stated that investment in advanced logic and storage chip-related businesses is recovering and expanding, and sales for the fiscal year ending in March next year are expected to grow by 20%, as global chip manufacturers continue to invest to meet AI-related demand.

According to the company's financial report, as shown in the chart, Tokyo Electron's Net Sales, Operating Income and Operating Margin, Net Income Attributable to Owners of Parent, and ROE all experienced varying degrees of decline in the previous fiscal year, compared to the previous two fiscal years. Only the gross profit margin increased slightly from 44.6% to 45.4% last year.

The main reason for this phenomenon is that compared to the past two years, customers' investment in semiconductor production equipment during the pandemic has slowed down in the past year, leading to a decrease in revenue. At the same time, R&D investment increased, reaching 202.8 billion yen, a year-on-year increase of 6%, which resulted in a slight decline in net profit margin despite the increase in gross profit.

Looking at the performance on a quarterly basis, Tokyo Electron (TEL) showed a clear trend of improvement throughout the entire previous fiscal year. Although TEL's fourth-quarter earnings did not meet the high market expectations, it has now entered a phase of recovery.

The image shows the operating status of the top 7 global semiconductor-related companies in the first quarter of 2024. The industry as a whole did not perform well in this quarter, but TEL performed relatively well, ranked second only to Screen among the companies listed.

In the company's disclosure, TEL divided its sales revenue into two parts: New Equipment Sales by Application (NES) and Field Solutions Sales. The first part, New Equipment Sales by Application, includes the company's three main types of semiconductor production equipment, accounting for nearly 75% of the total sales revenue. The specific content and sales situation are shown in the following chart:

The management expects that the global wafer fab equipment (WFE) market will grow by approximately 5% year-on-year to reach approximately $100 billion in 2024, and by 10% year-on-year to reach $110 billion in 2025.

China's revenue accounted for 44% of TEL's total revenue in the fiscal year 2024 (as of March 24), higher than historical levels. The proportion of sales to the Chinese market in total sales steadily increased and remained at a high level, reaching 47% in the fourth quarter, compared to only 23% in fiscal year 2022. This reflects the strong investment momentum and early procurement requests of Chinese companies to meet domestic demand and respond to the changing trade and investment environment. The company expects that the demand for semiconductor production equipment from chip manufacturers in China will continue to increase, which will have a positive impact on the company's performance and become an important source of driving force for the company's development in the next few years.

The demand from Chinese customers is mainly concentrated in the 28nm node, which may be due to concerns about further export restrictions. TEL expects China's contribution to fall below 40% in the second half of 2024, although demand from China remains strong.

In addition to the current growth in Chinese demand, driven by the overall prosperity of the market due to AI, it is expected that capital expenditures in the DRAM field outside of China will also see a strong recovery in the 2025-2027 fiscal years, driven by technology upgrades and new capacity. Currently, the company is transferring some of its production capacity from traditional DRAM production to higher-performance HBM (high-bandwidth memory) production to maintain its competitiveness in this area.

After the rebound of the DRAM business, it is expected that capital investment in the other two major businesses will fully recover in the next two years. The main driving force for this growth is the development of AI technology: AI will not only be integrated into servers, but also into PCs and smartphones. TEL expects that AI PCs and smartphones will account for 40% and 30% of its total shipments by 2028, roughly consistent with comments from AMD and Intel.

Although the demand from TSMC, the main customer of this business, was relatively mild in 2023-2024, significant growth in demand is expected in 2025-2027. This growth is mainly driven by the following factors: TSMC plans to invest in Taiwan to establish a production line for 2nm process technology, and also plans to expand the production of 3nm chips in the United States; TSMC plans to establish a second chip manufacturing plant in Japan, which will require a large amount of capital expenditure for the construction of new facilities and the purchase of production equipment.

For non-memory businesses, with Samsung announcing its skip of more than 300 layers and directly targeting over 400 layers, management expects 400-layer NAND to enter the scalable production phase in 2026. Technically, manufacturing will require more deposition processes and advanced etching techniques, especially higher requirements for etching, which provides TEL with an opportunity to win more market share from LAM Research, as TEL aims to use its low-temperature etching machine to bring customers higher efficiency improvements and utility cost savings.

Overall, the market outlook for TEL's performance is relatively optimistic. However, the stock price has already reflected most of the positive factors that can be assumed at present, so the room for valuation improvement is relatively limited.