Tokyo Electron, established in 1963 and headquartered in Tokyo, specialises in the design, manufacture and marketing of machines used in the production of semiconductors, 97.6% of FY24 revenue; and equipment to make flat screens, 2.4%. The company, with over 18,236 employees, is also a leading manufacturer of equipment used to fabricate integrated circuits (ICs) and has the largest installed IC fabrication equipment base in the world. Besides, the company is the only global manufacturer that supplies equipment covering the four stages of ultra-fine semiconductor manufacturing: deposition, coater/developer, etching and cleaning.

Strong R&D focus

Tokyo Electron, with a strong research and development (R&D) culture and decades of investments in developing cutting-edge technologies, has carved out technical leadership in the industry. The company has reported R&D spending of JPY600bn over 2018-2022 and plans to expend a further JPY1tn over 2023-2027. It has 16 R&D centres across the world, company-owned or in partnership with leading academic institutions and owns around 22,000 patents – a record in the semiconductor equipment production industry.

Cyclical industry driven by geopolitical trends

The semiconductor industry is cyclical in nature and had its most recent downturn in CY23. However, the industry has witnessed increased traction in AI demand in CY24, led by the WFE market which was estimated to be over JPY100bn. The market is also anticipated to be driven forward by investments for PCs, smartphones, and conventional servers. Additionally, the market recovery is anticipated to sustain in CY25 and record double-digit growth, led by further expansion in DRAM and resumption of investment in NAND as inventory adjustment progresses.

Consistent performance and improved outlook

Tokyo Electron’s revenue has grown at a 12.9% CAGR to JPY1,831bn and operating profit at a 20% CAGR to JPY456bn over FY15-24, with the operating margin expanding over an impressive 10.5% to reach 24.9%. Moreover, FCF has remained positive in the review period, touching JPY235bn in FY24, leading to a growing net cash position of JPY473bn at FY24 end. The company’s peer, Screen Holdings, demonstrated a similar trend in growth during the same period, registering a revenue CAGR of 8.7% to reach JPY505bn in FY24; operating income grew at a CAGR of 20.8% to JPY94.2bn, aided by margin expansion of over 11.4% to 18.6%.

In 2QFY25, the company delivered almost flat QoQ growth in net sales, however, it grew 32.4% YoY to JPY566.5bn. China contributed the bulk of the sales at 41.3%, followed by South Korea at 14.1% and North America at 14.1%. Operating income declined sequentially by 10.6%, but, increased 54.1% YoY to JPY148.1bn. The cash position including deposits and short-term investments increased to JPY525.5 bn at Sep-24 end, from JPY362.6bn at Sep-23 end. The rise is driven by favourable working capital movements.

The management has a progressive dividend policy and strives to maintain a payout ratio of around 50%. The company has declared interim dividends of JPY265 per share. Additionally, it has revised its full-year FY25 annual dividends forecast on the back of revision in financial guidance and now expects to pay annual dividends of JPY571 per share, reflecting a decent yield of 2.2% on current prices. Furthermore, the management has prioritised share buyback and decided to acquire up to JPY70bn of treasury stock from November 13, 2024, to January 31, 2025.

Volatile stock price

The stock is trading at a P/E of 23.9x, based on the estimated FY25 EPS of JPY1,133, comparatively lower than the global average of 31.8x. The company is also trading lower compared to its historical 5-year average P/E of 27.3x, signifying a recent downtrend in prices. However, Tokyo Electron’s peer, Screen Holdings, is trading at a steep discount, reflecting a P/E of 12.2x. The stock remained flat in the last one year, reflecting concerns over the US’s and Japan’s potential trade restrictions on exports to China. Out of the 19 analysts covering the company 10 have given a ‘Buy’ rating and 4 hold an 'Outperform' view for an average target price of JPY31,510, indicating a potential upside of over 21% from the current levels. The optimism amongst analysts is demonstrated through an anticipated CAGR of 16% in net sales over the period FY24-27 to reach JPY2,834.4bn.

Overall, Tokyo Electron presents a decent case for investment evaluation backed by robust fundamentals, with an industry-leading position, solid technical leadership and R&D culture, and strong industry tailwinds. Management has raised its FY25 guidance, underscoring its confidence in the company’s growth potential. On the other hand, ongoing geopolitical tensions, combined with material reliance on the Chinese market, may lead to underperformance compared to expectations, despite overall exuberance for the generative AI sector. The stock is also vulnerable to developments in frontier digital technologies, such as generative AI.