Exploring Growth in the Wafer Fabrication Equipment Market

Wafer fabrication equipment (WFE) is a set of machines that enable chipmakers like Nvidia, Apple, and TSMC to build better generative AI models and devices. They drive the cutting edge of electronics and generate over $100 billion in annual revenue. We predict a stronger growth cycle ahead than industry consensus, with a forecasted 8% annualized growth over the next five years. Furthermore, we believe WFE in isolation underestimates the total AI revenue opportunity for WFE vendors, with attractive growth in advanced packaging equipment and services increasing the total addressable market size by about 25%. 

Download our latest Technology Observer report for an exhaustive account of the WFE market, the factors driving growth, and Morningstar analysts’ top picks for investment.

AI is driving a rapid increase in global supply for advanced chips like GPUs and putting the chip industry on a rapid pace of complexity growth. Both of these dynamics are constructive to WFE spending and inform our bullish forecast.

Our five-year forecast comes above Gartner's WFE forecast, which we believe underestimates the level of AI investment over an enduring five-year period. Gartner's forecast appears especially low against our high growth estimates for chipmakers' capital spending. Our 17% annualized growth forecast for leading-edge chip investment matches our growth estimates for TSMC's capital expenditures, which are above sell-side consensus. 

We also see Gartner as overly bearish in its expectations for a steep correction in China demand, where we see it remaining at elevated levels. Our chief differentiation comes in 2027 and beyond, as we consider both AI investments and China's domestic buildout as durable over a longer-term period. In addition to expecting higher WFE growth than Gartner, we see advanced packaging as an incremental and attractive growth opportunity for these well-positioned wide-moat vendors.

In WFE, we see sales and growth as a function of global chip supply and complexity. Higher levels of supply require new equipment sales, and more complex chips require more advanced, higher-priced equipment. We expect AI to drive a significant increase in chip demand and these chips are advancing at a rapid cadence of complexity growth. Investors should think of chips being built from the ground up, layer by layer, to create a totally unique end product. This all starts with a wafer of a material, often silicon, but many others exist. Advanced logic chips for AI require thinner layers and smaller patterns, leading to higher use of etch, deposition, lithography, and process control.

Scaling refers to the trend toward greater circuit density in chips over time, which is the predominant driver of both complexity and growth. Advancing denser, more powerful, and more efficient chips requires both more advanced chip designs and more advanced equipment to physically implement those designs. Advances in chip complexity are never-ending and require consistent purchases of new, cutting-edge equipment to enable them.

Semiconductors are the backbone of every piece of modern electronics and are one of the most impressive and complex pieces of technology hardware ever created. Simply put, we would not have the cars, personal devices, or software we have today without these chips. Designing a cutting-edge chip is a complex feat on its own, but the manufacturing of these chips is where engineers truly push the limits of physics.

We believe our six covered WFE companies are the best-of-breed on the cutting edge of chip manufacturing with technology-driven wide moats. This group stands to be the primary beneficiaries of increased AI investment in chipmaking. We see this investment driving higher WFE spending, as well as higher advanced packaging spending. Advanced packaging occurs after WFE but is a new and growing market for WFE vendors to serve. 

Our top pick in WFE is ASM International. ASM is close to a pure-play on advanced deposition (atomic-layer, which we will describe in detail in the Technology Observer report) and stands to see higher penetration in AI chips. We expect it to gain market share and don't see the market pricing this in. 

ASML, Applied Materials, and Tokyo Electron look fairly valued to us but have underperformed peers like Lam Research and KLA year to date. While Lam and KLA have appreciated more than 80% year to date, ASML, Applied, and Tokyo have appreciated in the 10% to 45% range (Exhibit 2). To us, this is a disconnect, as we see all four as AI winners over the next five years. Investors making a play on AI growth in WFE should see fairer prices to these two than their overvalued counterparts.

WFE growth is a function of global chip supply and complexity. We observe a long runway for increasing complexity with new transistor architectures and advanced packaging, particularly for AI chips. Learn more about the market and its players in our latest Technology Observer report.