With tech companies continuing to boost AI spending, the valuation of many chipmakers are increasingly expensive.
(Bloomberg) — Chip stocks have become a favorite way to bet on artificial intelligence. But after big runups in companies like Broadcom Inc., investors are turning to an often overlooked group — suppliers of the gear used to make semiconductors.
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Teradyne Inc., a provider of tools used for testing chips during the manufacturing process, has nearly doubled from an April low and is up more than 50% since late July. Meanwhile, Lam Research Corp. and KLA Corp. — two of the biggest US makers of machines used to produce semiconductors — are the fourth- and fifth-best performing stocks, respectively, in the 30-member Philadelphia Stock Exchange Semiconductor Index this year with gains of more than 69%.
Earlier this month, Lam went on a 14-session rally, its longest winning streak on record, during which the shares soared 36%. And peer Applied Materials Inc. just posted its own eight-session streak that added 20%.
With companies like Microsoft Corp. and Alphabet Inc. continuing to boost spending on AI, and the valuations of many chipmakers looking increasingly expensive, equipment suppliers have become a destination for investors seeking growth at a more reasonable cost — although their valuations aren’t as enticing as they were now that investors are starting to pile in.
“The market’s clearly front-running the next AI capex wave, betting that fabs and cloud players keep spending aggressively,” said Haris Khurshid, chief investment officer at Karobaar Capital. “The catch is valuations have already run hard, so any pause in orders or delayed spend could hit fast.”
The gains follow a similar trend playing out in memory and storage hardware, another unsung corner of the tech sector.
Micron Technology Inc., which counts Lam Research and KLA as suppliers, has gained more than 90% this year amid soaring demand for high-bandwidth memory that’s critical in AI computing. South Korea’s Samsung Electronics Co. and SK Hynix Inc., which compete with Micron in supplying memory, are Teradyne’s biggest customers.
A strong outlook for spending on testing gear in the memory market was a reason Susquehanna analyst Mehdi Hosseini raised his price target on Teradyne to $200 from $133 last week. The stock closed at $134.33 on Monday, implying upside of 49%.
Teradyne’s expanding presence in several test markets including wafer sorting, which is expected to include Taiwan Semiconductor Manufacturing Co., is “a positive and incremental development that we believe is not entirely reflected in the current share price,” Hosseini wrote in a note to clients on Sept. 22.
One issue is that even tertiary AI plays like semiconductor equipment are starting to get expensive, raising risks in the event of a slowdown. Lam Research recently was downgraded by analysts at KeyBanc Capital Markets, who wrote that relative to the stock’s rally “we don’t think that a corresponding increase in consensus expectations or actual earnings power is imminent.” KLA Corp., which makes chip fabrication machinery, was cut at Morgan Stanley and CFRA last week.
Lam Research and KLA both began the year trading around 20 times profits expected over the next 12 months, and they’re now approaching 30 times. While that’s cheaper than the likes of Broadcom at 36 times, it’s above the average in the Philadelphia semiconductor index. Teradyne is priced at 33 times estimated profits, making it pricier than Nvidia Corp.
“The rally looks to be on shaky footing, since it seems like exponential investment in AI is the only way for it to keep up, and that seems unlikely,” said Adam Rich, who helps oversee more than $17 billion in assets as deputy chief investment officer and portfolio manager at Vaughan Nelson. “Right now everyone is winning, and if you’re part of the AI trade, that’s great, but no one wins forever.”
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–With assistance from Subrat Patnaik.
(Updates stock moves throughout.)
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