For the past few years, the semiconductor industries have been red hot and the top stocks were all but unstoppable. But this earnings season showed some weakness in a few company’s reports, and some on Wall Street are saying the cycle for the very cyclical sector has peaked.

One brokerage firm sees a few companies in particular slowing down a segment of the semiconductor industry. Merrill Lynch lowered its wafer fabrication equipment (WFE) estimates for 2018 to 2020 and now expects WFE to decline modestly (−2.5% year over year) next year versus +2% prior.

The firm issued a couple downgrades for some firms. Merrill Lynch mentioned the overriding reasons as: investments shifting to foundry/logic from memory; limited operating leverage with margins close to peak; muted growth and multiple contraction; services/China bright spots, but can’t offset muted WFE.

Merrill Lynch’s Vivek Arya and the research team had this to say in the report:

Following recent memory and foundry push-outs we lower our WFE outlook for this year to +7% from +10% year over year. We also lower our estimates for 2019/20 to -2.5%/+2.5% from +2%/+5% year over year owing primarily to lower memory capex, which we now expect to decline 7-8% next year (vs. flat to up 1% previously). Most companies guided for a trough in Sep/Oct Quarter followed by a return to growth starting in Dec/Jan Quarter, but in our view it still remains unclear when spend will start to reaccelerate in earnest – we don’t expect year over year growth to accelerate until at least second half of 2019. Additionally, recent push-outs serve as a reminder that visibility is still limited (only 3-6 months) despite significant industry consolidation over the last several years.

As a result Applied Materials Inc. (NASDAQ: AMAT) and Lam Research Corp. (NASDAQ: LRCX) were downgraded to Neutral from Buy on muted earnings growth, owing to softening WFE and limited operating leverage. At the same time, Merrill Lynch maintained a Buy on KLA-Tencor Corp. (NASDAQ: KLAC,) which is more defensive due to higher logic/foundry and technology exposure versus memory and production.

The report specifically detailed:

In turn, we are downgrading Lam Research and Applied Materials from Buy to Neutral given the muted growth environment coupled with margins that are near/at peak levels, limiting earnings growth and offsetting low valuation. We maintain our Buy rating on KLA, which we see as more defensive since it is levered more to technology transitions than production.

Shares of Lam Research were last seen down about 2% at $171.97, with a consensus analyst price target of $241.55 and a 52-week trading range of $156.83 to $243.88.

Applied Materials shares were down about 1% at $43.33. The consensus price target is $62.82 and the 52-week range of $42.52 is $62.40.

KLA-Tencor traded down 0.5% to $116.88 a share, in a 52-week range of $90.29 to $123.96. The consensus price target is $135.43.

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