AI Chip Demand Soars, But Equipment Makers Face Headwinds: TSMC Strong, ASML Weak

AI Chip Demand Soars, But Equipment Makers Face Headwinds: TSMC Strong, ASML WeakOctober 18 Demand for artificial intelligence (AI) chips is booming, but for semiconductor equipment makers, that growth doesn't always translate into significant profits. This week, that divergence was on full display

AI Chip Demand Soars, But Equipment Makers Face Headwinds: TSMC Strong, ASML Weak

October 18 Demand for artificial intelligence (AI) chips is booming, but for semiconductor equipment makers, that growth doesn't always translate into significant profits. This week, that divergence was on full display.

Taiwan Semiconductor Manufacturing Co. (TSMC) released strong third-quarter earnings on Thursday, predicting more than a tripling of revenue this year from "server AI processors," including Nvidia's popular chips. This seems to point to the continued heat of AI chips. However, earlier this week, ASML delivered a rather bleak performance report. The Dutch equipment maker revealed that its net bookings in the third quarter were only 2.6 billion (about $2.8 billion), less than half of what Wall Street expected. This is certainly a blow for the maker of lithography equipment, which manufactures advanced chips. ASML further stated that it expects revenue in 2025 to be close to the lower end of previous forecasts.

These contrasting reports caused huge swings in the market. Since ASML unexpectedly released its report one day early on Tuesday morning, major U.S. semiconductor equipment manufacturers such as Applied Materials, Lam Research, and KLA have seen their shares fall 13% to 18% over two days. During this period, ASML's own market value also shrunk by 20%. Fortunately, TSMC's earnings release on Thursday provided some boost to chip stocks, pushing the Philadelphia Semiconductor Index (PHLX Semiconductor Index) up about 2% in early trading.

Analysts widely predict that, despite numerous challenges, total sales of global chip manufacturing equipment are expected to exceed $100 billion for the first time this year. However, the industry is dominated by a few major companies. TSMC announced on Thursday that its capital expenditure this year will be slightly higher than $30 billion, hinting that spending next year may "likely" increase further.

Meanwhile, two other major chip equipment customers are facing difficulties. Intel's share of the data center and PC markets continues to decline, coinciding with the company's attempt to implement a massive turnaround plan, forcing the once-mighty chip giant to cut capital expenditures to maintain cash flow. According to VisibleAlpha, a financial technology provider, Wall Street expects Intel's capital expenditures to fall 8% this year and 15% next year.

Last week, Samsung apologized to investors for its missteps. As the world's largest manufacturer of memory chips, Samsung lags behind its competitors in the specialized memory needed for AI. VisibleAlpha found that analysts expect Samsung's chip-related capital expenditures to decline by 4% this year but are expected to return to 2023 levels next year. Samsung may further adjust its spending plans later this month when it releases its full third-quarter earnings.

In addition, China has been actively investing in building its domestic chip industry, as the U.S. tries to restrict China's access to the most advanced chips and manufacturing equipment. Sales to China have historically accounted for 14% to 18% of ASML's annual sales, but this share jumped to 29% last year and averaged 48% in the first three quarters of this year. However, analysts have long expressed concerns about the sustainability of this surge in spending, and current data suggests that this growth is unlikely to continue.

Christophe Fouquet, ASML's CEO, said on a conference call on Wednesday following the company's earnings report, "We expect the China business to return to a more normalized level within the company's overall business," predicting that China will account for 20% of the company's revenue next year.

In a market still driven by AI hype, investors need to be cautious, but that's easier said than done. TSMC's Thursday earnings report predictably boosted shares of Nvidia, Micron Technology, Broadcom, and other companies that directly benefit from increased AI demand. However, for equipment makers, the market environment is more complex and volatile. Their customers are not only grappling with slowing PC demand but also facing uneven smartphone sales and a sluggish automotive market.

From the launch of ChatGPT at the end of 2022 to July 10 of this year, Applied Materials, Lam Research, and KLA all saw their share prices double and hit record highs. However, according to S&P Global Market Intelligence, these companies' total revenue actually declined by 9% in the past 12 months. Even after this week's sharp decline, FactSet data shows these stocks still trade at an average premium of 10% relative to their five-year average expected P/E ratio.

"One mistake many investors and inexperienced analysts are making is interpreting the huge success of AI as an indicator of a boom in the entire chip market," noted Robert Maire of semiconductor advisory firm SemiconductorAdvisors on Wednesday. It's worth noting that Nvidia's stock surge hasn't benefited everyone.

In conclusion, although AI chip demand continues to grow, equipment makers face challenges that should not be ignored. The complexity of the market environment and the uncertainty of customer demand make the future development of equipment makers full of variables. Investors in this area need to exercise caution and closely monitor the financial performance and market dynamics of related companies.