Despite concerns of slowing industry sales dampening the overall outlook for the chipmaking sector, a couple of key players in the chipmaking space still have strong upside potential. While slightly lowering their price targets for Applied Materials Inc. (AMAT) and Lam Research Corp. (LRCX), Morgan Stanley analysts Joseph Moore and Craig Hettenbach are still overweight on the two chip-equipment makers and see at least 25% for both. The analysts cited continued strength in capital spending from significant buyers on wafer fab equipment (WFE), which is used to manufacture microchips, as well as an uptick in spending from China, according to Barron’s.
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The major issue weighing on WFE sales this year is the “Samsung DRAM push-out,” referring to reports of production delays of DRAM memory chips by one of the only three DRAM producers; the other two being Micron and SK Hynix. Whether this is due to technical manufacturing issues or just Samsung looking to manage its supply in order to maintain higher prices, the result is the same—lower spending on WFE. There have also been similar small push-outs in NAND production as well as slight delays in foundry, noted the analysts.
Due to the delays, Moore and Hettenback cut their forecast for WFE sales by the chip-equipment industry from $54 billion to $52 billion. While still 5% above last year’s level, it is 5.5% below the $55 billion suggested by the “run rate,” a projection of future results based on an extrapolation of first quarter sales data. (To read more, see: Chipmakers to See Slow Phone Sales: Morgan Stanley.)
Spending Bright Spots
In spite of these issues, the analysts see a number of bright spots coming from the other two big memory chip producers, as well as increased spending from China. The analysts wrote, “Micron has already indicated that capex next year will be higher, and we see Hynix spending shifting towards WFE. We still see potential upside from China sovereign spending,” according to Barron’s.
While a trade war could weaken the prospects from that last factor, the total spending from China is still relatively small. In the bull case scenario, China increases spending, providing a slight boost to overall WFE sales, while in the more bear case scenario, a trade war curtails that spending but with limited effects to overall industry spending. (To read more, see: US Urges China to Buy More Chips, Cut Auto Tariffs to Avert Trade War.)
Bargain Buys for Patient Investors
Consensus sales and earnings forecasts for the current year are 21.50% and 41.20% respectively for Applied Materials, and 37.40% and 74.8% respectively for Lam. Considering the still strong growth potential and with both stocks trading at significant discounts to the overall market (forward P/E ratios for Applied Materials, Lam, and the S&P 500, at 10.05, 10.18, and 17.45, respectively), the two are looking very cheap.
That perspective is one shared by Stephanie Link, the managing director and U.S. equities manager at Nuveen. However, she cautions that there are concerns that the current cycle is peaking, noting that investors may have to wait to get through the next couple of quarters before seeing the trade paying off. “Be in it,” but “be patient,” she told CNBC’s Halftime Report on Friday.