BackChip-making machines face a problem of uncertain demand
Global flux has warped the usual cyclicity of this crucial industry
PremiumA huge shortage of semiconductors wreaked havoc in many sectors over the past two years. There weren’t enough machines to make the chips, either. To fix the problem, firms announced billions of dollars of capital spending for new facilities. But before these have even come online, there’s already a glut. Companies don’t seem too perturbed, though, nor do investors. Some chip machinery maker stocks are trading at heady valuations. They are finding comfort in the backlog of orders that will tide these firms through troughs. Those that aren’t sitting on cushy buffers will wait it out as they’ve done in years past. SEMI, an industry association, projects a 17% drop in front-end process equipment. For others that cut wafers into chips, a back-end process, sales are likely to drop 9%. The forecast downturn follows record sales of chip-making equipment that rose to $107.6 billion in 2022.
A complex cycle is getting even trickier to predict. Usually, companies forecast demand two years in advance, ordering tools and building factory shells without filling them with machines. The chip cycle turns every three to five years. Every time, it’s consistent, falling for a few years and bouncing back up, even if the exact timing, depth and speed of the rebound is harder to determine, says Peter Hanbury of Bain & Co. In downturns, cash costs are so low companies keep running plants, but future capital gets cut. Firms have worked out how to deal with predictable variables and are immune to ups and downs. The broader upward trajectory keeps manufacturers churning out equipment that will sooner or later get installed in fab units.
Or that’s how it used to be. There is now a new and meaningful set of variables to consider. Those range from export restrictions on Beijing, significant investments made by Chinese producers to huge government subsidies and incentives handed out by the US and Europe, along with geopolitical tensions and rising tech costs. Executives at one of the largest machinery makers, Lam Research, called the broader changes in the industry “an unprecedented business environment" during the company’s earnings call in late January. Forecasts that don’t take these factors into account—or underestimate their impact— are likely to be far too optimistic.
So it’s worth considering the following blind spots. First, what if Chinese companies, which currently buy over a quarter of global chip equipment, end up making their own products (even if lower-tech to begin with), while shutting out Japanese players? That’s what happened in the construction machinery sector; homegrown champions have improved so much that they’re finding markets overseas. Sure, chip-making gear is much more sophisticated and needs the kind of precision that China perhaps doesn’t have yet. Right now, these firms are manufacturing for the home market, pushing out overseas businesses as they make better products. That will shift the finely tuned demand-supply balance over the next few years and eat into Japanese players’ large share in China.
Next, what does it mean for machinery makers as industrial technology evolves and end-market demand changes? Days of consumers buying loads of PCs and smartphones (because of unprecedented demand during covid) are clearly numbered, given cutbacks from the likes of Samsung. The bigger and more lucrative wins will come from large-scale decarbonization transitions. Power chips, for instance, are being pushed aggressively in China as they are a key semiconductor used in EVs and other emerging sectors that Beijing is focused on. Firms like Zhejiang Jingsheng and Naura Technology are developing equipment to make these components. Meanwhile, companies such as Japan’s Screen Holdings report that in the Chinese market, investment appetite outside restricted areas is “still active."
Capital intensity (including some help from government subsidies) for the broader chip-making equipment market has continued to rise as technology is refined and customer needs get more sophisticated. Higher raw material prices have also eaten into profitability. Unfazed, chip machine makers are expecting an uptick in 2024. The quickest growth will come from Europe, the US and Japan, SEMI notes, as capacity rises.
For now, some firms are turning to solutions that have worked in the past. They’ve delayed projects and postponed payments. Others are pushing out expansion plans. The industry association said last month spending will be down 22% this year, worse than previously expected just four months ago. Yet, companies aren’t cancelling plans outright, hoping that cyclicality will play out. That will muddy forecasting further. With even more looming uncertainties, chip-machine makers could do with a deeper reassessment.
Anjani Trivedi is a Bloomberg Opinion columnist covering industrials across Asia Pacific.
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