While Nvidia’s dominance in AI GPUs is more clearly visible downstream in the HBM market, it’s also driving growth in a lesser-known but equally as important market, in metrology/process control equipment.
Metrology, by definition, is the study of measurement. In the semiconductor industry, metrology plays a critical role, as the ability to measure circuit dimensions, microstructures inside chips, film thickness, accuracy of layers and overlays are all necessary to ensure chipmakers can consistently produce high-quality, flaw-free chips at high yields.
While KLA dominates the metrology market, reportedly holding a more than 50% market share for over 20 years, Onto Innovation and Nova are two smaller players in the market putting up accelerating revenue growth with strong margins, with exposure to AI megatrends and long-term growth drivers.
Metrology Has Multiple Drivers
The metrology market has multiple drivers of future growth, and while it’s not limited to the AI data center mega-trends spearheaded by Big Tech, there are many levers within this AI buildout to drive demand for Onto Innovation and Nova.
This is how Nova’s management team recently described the opportunity: “Artificial intelligence is reshaping our digital world and expediting the implementation of scaling agents in integrated circuits to boost performance and power efficiency which are at the core of enabling large language models through training and infra stages. Scaling is manifested in more complex designs through three avenues, dimensions, materials and advanced packaging.
It is also manifested in the size of manufactured dies and in the number of dies required in solutions such as high bandwidth memory. These developments profoundly impact our industry in the number of the wafers needed to supply demand and in the yield ratio, you must obtain to secure profitability with a lower number of dies per wafer. Couple that with the growing complexity of architecture and materials and you have the growth drivers of process control in the coming years.”
Here’s a brief look at how AI and the data center are generating demand for metrology equipment across these different drivers:
Shift to Advanced Nodes
Advanced nodes require more process steps as node sizes shrink, so for a chipmaker or foundry like TSMC or Intel to move from primarily producing on 5nm nodes to 2nm or below over the next couple of years, there will be a greater need for metrology equipment. Currently, the 5nm and 4nm nodes are primarily being used for AI chip production, such as that for Nvidia’s Hopper and Blackwell chips, while 3nm production is ramping at TSMC with volume production at the 2nm node expected in 2025, primarily for smartphone applications.
This is because the manufacturing tolerances shrinks as nodes shrink in size – the chipmaking process now becomes increasingly more sensitive to minute deviations in the process. Moving to more advanced nodes warrants much greater precision throughout the entire manufacturing process, as the smallest of deviations could greatly affect the process’ yield.
For example, Samsung has reportedly been struggling with severe yield issues for its most advanced nodes, with unstable yields reportedly around 50% or below for its gate all-around GAA 3nm second-gen process, and yields as low as 20% for its 2nm process.
TSMC sees higher yields for the 3nm process, reportedly between 60% and 70%, allowing it to command a majority of production on advanced nodes and thus a majority of market share.
Source: Nova
Rising Chip Complexity
Metrology needs also rise as chip designs get increasingly complex, from the entire GPU to memory cubes.
AI accelerators are getting larger and more complex with each generation packing more transistors than the last. Nvidia’s upcoming B200 GPU packs 208 billion transistors and 192GB of HBM3e memory, versus 80 billion transistors and 80GB HBM3 memory for the H100. Though Blackwell is in a dual-die configuration, it’s still a more complicated chip to produce using TSMC’s customized N4P process (the same as for the H100).
Having a more complex chip design increases the chances of errors, as there are more steps in the manufacturing process to produce said chips. This also goes for DRAM and NAND cubes – as HBM cubes stack higher, from 8-high cubes to 12-high cubes for the current HBM3e generations from SK Hynix, Samsung and Micron, it also increases process steps. Other advanced memory chips have seen a 6x increase in layers from 64 to 400 over the past few years. 3D stacking and building more layers necessitates more sophisticated metrology equipment to ensure critical measurements are met within each stack and layer.
Gate All Around Advanced Packaging
TSMC is phasing out FinFet after the 3nm node, and its upcoming 2nm node will be the first to use gate-all-around field-effect transistors (GAA FETs). GAA will increase chip density, and increase performance-per-watt to enable higher levels of output and efficiency.
These GAA nanosheet transistors have channels surrounded by gates on all sides to reduce leakage yet it will also uniquely widen the channels to provide a performance boost (with another option to narrow the channels to optimize power cost). The 2nm node will also allow chipmakers to customize the width and height of cells. Because of the increased complexity of GAA FETs compared to FinFETs, Nova estimates that GAA requires 20% to 30% more metrology steps than FinFET.
We’ve covered gate-all-around in a TSMC analysis that stated the following in terms of timing for N2 starting production in the last quarter of 2025 and reaching “meaningful revenue” by the Q1 to Q2 of 2026.
Accelerated Chip Development Timelines
Nvidia and AMD are both shifting to annual release cadences, aiming to bring next-generation GPUs to market once per year, compared to prior cadences of every two years. This is a major technological feat – as we had said previously for Nvidia, it’s a ‘move-fast-break-things’ problem, where Nvidia is pushing the boundaries of what had previously been seen as impossible in the chip industry.
By moving to these quicker release cycles, there’s a much greater emphasis on metrology and process control to ensure that the manufacturing process remains sharp, while also ensuring a faster ramp, and high yields to meet mass production thresholds and demand.
Fab Buildouts
Another driver for metrology equipment is chip fab buildouts, such as HBM fab construction and investments from SK Hynix, Micron and Samsung, as well as other expansion plans, such as TSMC’s planned expansion in Arizona.
Onto’s management put this in perspective from the HBM side, saying that “even if AI just stayed flat, which nobody is projecting, AI is supposed to go up, the HBM side is already doubling. … customers [are] talking about supply constraints and that they're looking at expanding factories into next year, early half of next year in order to alleviate these supply constraints.”
Currently, there are 19 global high-volume chip fabs under construction this year, with another 10 expected to be added next year to meet rising demand for semiconductors, driven by AI/HPC. Total equipment spending for these 29 fabs is expected to be approx. $140 billion. Through 2030, there are more than 100 fab projects planned, with more than $200 billion in global funding and incentives for these projects.
Building out new fabs from the ground-up will require metrology and process control equipment, providing a long-term growth runway for the industry.
Product Snapshot: Addressing Critical Challenges in Advanced Packaging, Memory, More
Onto and Nova’s management teams highlighted a few core products that are driving growth or seeing strong orders and adoption from major customers. These products address some of the more pressing challenges in advanced packaging, HBM and memory, and leading-edge nodes.
Israeli-based Nova has a diverse metrology equipment and software portfolio, from dimensional to materials to chemical metrology. One of Nova’s leading products is PRISM 2, the next-generation PRISM which offers improved sensitivity and accuracy in critical dimensions metrology.
Nova noted that its PRISM 2 product saw strong adoption last quarter, especially in GAA, with around half of its record bookings stemming from “advanced packaging processes, such as Through-Silicon Via, where PRISM has a unique advantage in filtering information from specific underlayers.”
PRISM 2 provides improved accuracy and reliability for critical component measurements in processes such as advanced logic chip fabrication and stacking nanosheets for GAA fabrication, as well as 3D NAND and DRAM.
Nova also added that “demand is also consistently high for our advanced integrated metrology and XPS material metrology platforms,” as it saw “record booking of VeraFlex XPS platforms this quarter, of which over 40% resulted from capacity growth” in FinFET advanced nodes.
Nova’s VeraFlex XPS (X-ray photoelectron spectroscopy/materials metrology) helps analyze surface structures, identifying bonding, contaminants or defects in advanced nodes for process control in high-volume manufacturing.
US-based Onto’s core products span defect inspection equipment, dimensional (optical CD) and material metrology, and lithography tools. Onto’s Dragonfly systems, which drove Q2’s performance, witnessed “better-than-expected demand” for advanced packaging for AI chips as it reached another revenue record.
Dragonfly G3 provides combo 2D and 3D inspection and process control for advanced packaging, HBM and chip-on-wafer GPUs. For example, Onto noted last August that it finalized more than $100 million in Dragonfly G3 orders for chip packages “that combine a graphics processor (GPU) and numerous high bandwidth memory (HBM) devices to create an AI GPU in a single package.”
Onto also said that Atlas and Iris demand for GAA investments were a driver of Q2’s performance, while new product launches in panel lithography, 3D bump metrology sensors for smaller interconnects in HBM, and subsurface defect inspection sensors are expected to see strong adoption through the end of the year.
By comparison, leader KLA offers a comprehensive portfolio of metrology equipment for measuring “pattern dimensions, film thicknesses, layer-to-layer alignment, pattern placement, surface topography and electro-optical properties” for chip and substrate manufacturing, from new process development, product verification, and high volume manufacturing. KLA provides advanced wafer packaging equipment, overlay metrology equipment, reticle metrology and inspection tools, OCD, shape and film metrology equipment, sheet resistance metrology equipment, and more.
Customer Concentration Extremely High
It’s common for small cap semiconductors to have high customer concentration, especially at the equipment level, as there are a limited number of fabs globally. Nova and Onto are no exception.
For Nova, its top five customers accounted for 52% of revenue in 2023, down from 57% of revenue in 2022 and 70% in 2021. Nova’s largest customer accounted for 19% of revenue, while its fifth largest customer contributed 5% of revenue. The customers are not named.
Revenue from Nova’s largest customer(s) declined from ~$130 million in 2021 and 2022 to $108 million in 2023.
Source: Nova
Onto Innovation has provided a breakout for its top three customers, along with another figure that highlight its customer concentration.
For Onto, its three largest customers accounted for 56% of revenue in the first half of fiscal 2024. TSMC accounted for 23% of revenue, up from 13% in the same period last year. Samsung accounted for 20% of revenue, down slightly from 21% last year.
SK Hynix has risen to be Onto’s third largest customer at 13% of revenue, up from <10% last year. Onto also has shared that TSMC accounted for 21% of its net accounts receivable in the first half of 2024, with Samsung accounting for 8%.
Source: Onto Innovation
Revenue Accelerating
Both Nova and Onto are reporting accelerating revenue growth in Q2 after returning to growth in Q1 this year after four consecutive quarter of declines. However, Onto guided for revenue growth to decelerate in Q3, while Nova forecast this acceleration to continue but be short-lived.
Onto reported 27.1% YoY growth to $242.3 million in revenue in Q2, accelerating from 14.9% growth in Q1. Management said that Q2’s growth and revenue above its guided $230-240 million range was “driven by additional pilot line expansions for high-performance computing using gate-all-around transistor architecture and high bandwidth memory (HBM) supporting AI market growth.” This was likely driven primarily by increased spend by TSMC and SK Hynix, seen within the customer concentration figures.
Advanced packaging and specialty device revenue reached a fourth-consecutive record at $164 million, up 49% YoY, while Onto added that it “closed over $300 million of volume purchase agreements issued by two customers for their AI advanced packaging and gate-all-around investments through 2025,” again likely to be coming from TSMC. Management expects that GAA and advanced packaging at multiple customers will be primary growth drivers through 2025.
Nova reported revenue growth of 27.8% YoY to $156.9 million in revenue in Q2, accelerating from 7.3% in Q1. Metrology product revenue was $124.6 million, accelerating to 30% YoY growth from just 6% YoY in Q1 and (16%) in Q4.
Management said that it saw “record revenue from chemical metrology, driven by demand in high-bandwidth-memory and front-end logic processes,” while demand for GAA and advanced packaging was increasing with “faster-than-expected adoption” for its PRISM 2 platform. Management added that they also saw record bookings for advanced packaging and materials metrology.
Q2 also marked both companies’ fastest YoY growth rates in two years — here’s a look at how Onto and Nova have recovered from 2023’s slowdown:
Looking ahead for Q3, Onto guided for revenue growth of 20.7% YoY to $250 million in revenue at midpoint, a more than 6 percentage point deceleration. Nova forecast a nearly 6 percentage point acceleration to 33.5% growth to $172 million in revenue at midpoint.
Through 2025, analysts expect Onto to maintain growth in the high-teens each quarter, while Nova’s higher growth rate of 30%+ is expected to decelerate into the low-teens and high-single digit range five quarters out.
Onto is expected to see quarterly revenues rise to above $300 million, while Nova is currently forecast to see revenues begin to flatline in the mid-$190 million range. Nova may be more exposed to cyclicality in the metrology industry with its focus on film metrology equipment, which may see faster growth in the ramp phase that stabilizes later on.
Onto provided a quick look into what’s driving 2025 growth: “We expect to benefit from continued investments in gate-all-around capacity, and the announced capacity expansions from several high-bandwidth memory and logic packaging manufacturers, specifically for HBM. We expect new capacity coming online in the first half of the year to support the increase of HBM content for NVIDIA's AI processors from 80 to 192 gigabytes and for AMD's AI processors from 192 gigabytes to 288 gigabytes.”
However, it’s not all AI revenue for the two. Onto clarified that AI packaging drove over half of specialty and advanced packaging revenue in Q2, implying AI packaging revenue of at least $82 million, or just over one-third of quarterly revenue. Nova is seeing demand stem from AI-driven end markets such as HBM, GAA and TSVs, though they have not broken out AI’s specific impact on revenue.
Long-Term Financial Targets:
Revenue
Both companies have set out long-term financial targets, including revenue, margins and EPS. The revenue targets will likely be achieved in 2027 to 2028 based on current expectations and historical trends. Both companies expect to have enough capacity by year end to reach these long-term revenue targets.
Nova set its long-term target of $1 billion, more than 50% higher than FY24’s projected $648 million. There are currently six analysts covering Nova with only two analysts providing estimates through Dec of 2027 with consensus at $995.7 million.
Here's Nova’s target model:
Source: Nova
Onto has its long-term revenue target at $1.8 billion, nearly double FY24’s projected $980 million. There are eight analysts covering Onto with only three analysts covering the stock through Dec of 2027 with estimates at $1.56 billion. The Dec 2028 estimate is more in line with Onto’s projections with only one analyst providing an estimate of $1.84 billion.
Here’s Onto’s target model, which provides a more detailed view down the line as revenue increases incrementally by $200 million:
Source: Onto
Margins
Nova is currently ahead of its long-term margin targets, currently benefiting from higher ASPs due to product mix, while Onto is behind on gross margin targets for its $1 billion model.
Here’s how Nova’s margins look relative to its long-term target (referencing non-GAAP margins):
- Nova reported GAAP gross margin of 59% in Q2, flat QoQ and up 200 bp YoY. Non-GAAP gross margin was 61% in Q2, again flat QoQ and up 200 bp YoY.
- For Q3, Nova guided gross margins to dip 300 bp QoQ sequentially, to a GAAP gross margin of 56% and non-GAAP gross margin of 58%. Nova said that faster adoption of higher ASP/margin products has previously boosted margins, but they remain at the high-end of targets despite this fluctuation.
- GAAP operating margin was 29% in Q2, expanding 300 bp QoQ and 600 bp YoY. Non-GAAP operating margin was 34%, up 200 bp QoQ and 600 bp YoY. Management pointed out that non-GAAP operating margin was ahead of targets of 27% to 31%, and while Q3’s non-GAAP margin was guided to decline sequentially to 32%, this is in line with previous quarters with Q2 being a strong outlier.
Onto sits behind gross margin targets, though it sees margins expanding in the coming quarter.
- Onto reported GAAP and non-GAAP gross margin of 53% in Q2, up 100 bp QoQ and flat YoY. Though current FY revenue estimates are just 2% below the $1 billion target model, gross margins are shy of its range, with Onto targeting non-GAAP gross margins of 56% to 57%.
- For Q3, management guided to gross margins between 53% to 55%, flat to up 200 bp QoQ, driven by growth in advanced nodes and optimization in manufacturing. Though it’s a step in the right direction, it’s still short of targets by ~200 bp at midpoint.
- GAAP operating margin was 20% in Q2, up 100 bp QoQ and 700 bp YoY. Non-GAAP operating margin was 27%, up 200 bp QoQ and 600 by YoY.
- Excluding amortization (to align with long-term targets), non-GAAP operating margin was 32%, in line with the high end of the $1 billion model despite the gross margin shortfall.
- For Q3, management’s guidance implies non-GAAP gross margin of 28%, up 100 bp QoQ.
EPS
Both Nova and Onto are reporting strong EPS growth, with Nova reporting 48% YoY growth to $1.41 in GAAP EPS of $1.41 and Onto reporting 102% YoY growth to $1.07 in GAAP EPS. It’s rare to see such high EPS numbers from small cap stocks, and long-term targets are both strong and rather achievable.
For Nova, management is targeting non-GAAP EPS of at least $7 per share by the time it reaches $1 billion in revenue. For the first half of 2024, Nova’s non-GAAP EPS is currently $3 per share, suggesting that if margins can be maintained at the high end of its model, $7 in EPS is easily achievable. Analyst estimates currently project $9.58 in EPS on $996 million in revenue in 2027, foreseeing Nova surpassing the $7 EPS target next year on $757 million in revenue.
Onto is targeting non-GAAP EPS of $5.50 to $6.00 at $1 billion in revenue, and long-term up to $8.50 in EPS at $1.4 billion in revenue. Non-GAAP EPS for the first half of 2024 was $2.50, and with Q3 guided to $1.30 at midpoint, Onto would need to report $1.70 in non-GAAP EPS in Q4 to reach the low end of its target at $5.50.
Onto’s longer-term view emphasizes increased operating leverage to drive earnings growth as gross margin expansion is minimal. Management is eyeing just a 2% expansion in gross margin but a 4% expansion in operating margin. This is expected to drive EPS more than 40% higher, from $6 to $8.5 per share at the high end of the range. Analysts are much more optimistic on the degree of operating leverage that Onto can drive at $1.4 billion in revenue, with estimates calling for about $9.35 in EPS on $1.44 billion in revenue in 2026. Again, it’s rare to see EPS numbers this high with small cap semiconductor stocks.
Balance Sheets, Cash Flows Healthy
With operating and net margins in the high-20% to low-30% range, Onto and Nova enjoy healthy balance sheets and cash flows.
Onto has $786 million in cash, equivalents and marketable securities on hand, zero debt, and total liabilities of $174 million. Operating cash flow for 1H 2024 increased 50% YoY to $122 million, or 26% of revenue (versus 21% of revenue in same period last year). Free cash flow rose 49% YoY to $103 million, or 22% of revenue (versus 18% of revenue in the same period last year).
Nova has $759 million in cash, equivalents, and marketable securities, and $198 million in convertible senior notes, which, if converted, would equal about 3.4% dilution to existing shareholders. Nova has no outstanding debt outside of the convertible notes. Operating cash flow for 1H increased nearly 154% YoY to $120 million, or 40% of revenue (versus 19% of revenue in the year ago period). Free cash flow rose more than 178% YoY to $115 million, or 38% of revenue (versus 17% of revenue in the year ago period).
Inventories are where the two differ, with Nova increasing inventory as Onto is working to reduce inventory. Nova reported inventory of $156.6 million at the end of Q2, up more than 13% from the end of 2023. Onto is working on inventory management, reporting $319.7 million in inventory in Q2, down from $327.8 million at the end of 2023. Management expects to further reduce inventory by $10 million to $15 million in Q3 and exit 2024 with inventory below $300 million, or a $50 million YoY reduction.
Valuations Have Enjoyed a Premium
With clear exposure to AI and HPC trends in HBM and advanced packaging, as well as strong operating, net and cash flow margins — and triple digit cash flow growth for Nova – the two have recently enjoyed premium valuations to other chip equipment stocks and metrology leader KLA.
Onto currently trades at nearly 62x TTM earnings and Nova at almost 42x TTM earnings, compared to 38x TTM earnings for KLA and 22x TTM earnings for Applied Materials, which also has exposure to metrology and advanced packaging. Multiples have compressed slightly, with Onto trading above 80x earnings and Nova above 55x earnings earlier this year; however, it’s quite a large premium to their three-year average TTM earnings multiples of 37x for Onto and 31x for Nova.
On a forward basis, strong EPS growth of 40% YoY for Onto and 31% YoY for Nova has brought forward multiples lower, though still elevated relative to peers. Onto trades at nearly 40x forward earnings of $5.22 for FY24, while Nova trades at 31x forward earnings of $6.37 for FY24. KLA trades at 26x forward earnings with 25% YoY growth expected, and Applied Materials at 23x forward earnings with just 6% YoY growth expected.
On a top-line basis, Onto, Nova and KLAC are currently trading in the high 10x, to mid 11x PS range. Multiples for the trio have been in lockstep for more than a year, following each other quite closely since the 5-6x range around Nvidia’s blowout earnings report in May 2023, the first signs of the present AI and HBM boom.
Looking longer-term, it’s quite clear that these are some of the highest top-line multiples Onto and Nova have traded at in the past decade. Both companies’ 10-year average PS multiple hovers around 4.5x to 5x, so the two are currently trading at more than double their 10-year average. If earnings or revenue growth falters, multiple compression is a possibility given the premium valuations of the two.
Technical Analysis
By Knox Ridley
What caught our eye about the technical patterns in both NVMI and ONTO was how similar their long-term trends appear to be unfolding. Like many AI names that we track, they appear to be setting up for a correction within a larger uptrend that should go on for several years.
Most stocks and markets appear to have either topped in 2021 or are in their final swing higher in 2024/2025. So, while the broad market makes a series of lower highs into the coming years, these names would trend higher.
Onto Innovation (ONTO)
The below chart is a weekly chart. In other words, every candle is one week’s worth of price data. This better helps us decipher the long-term trend. Note the vertical move off the 2009 low, which was followed by a multi-year, messy and overlapping correction into 2015. This best resembles waves 1 and 2 in a very large 5 wave uptrend.
This is further supported by the price action into today’s developing top. The below Elliott Wave count has us in the final swing of wave 3 within the larger 3rd wave. We ccould see a final push into the $257 – $339 region. However, this is not a move that we would chase, considering the warning signs.
For one, we have a completed 5 wave pattern off thew COVID low. What follows 5 waves higher is usually a 3 wave retrace. Secondly, since mid-2023, we have seen price make higher highs while momentum is making lower highs. This is characteristic of 5 wave pattern, where peak momentum typically is seen in wave 3, as we wave 5 is met with less volume and less momentum.
Nova (NVMI)
NVMI has a similar long-term chart as ONTO. We can see a near vertical 5 wave move off of the 2009 low, followed by a pullback into 2011. This lines up well as waves 1 and 2 of a very large 5 wave pattern.
Like ONTO, Nova is in the final swing of wave 3 of the larger 3rd wave. If this count is accurate, the 4th wave pullback should take us back to around projected the halfway point of this larger 5 wave pattern, which is where we would look to potentially enter both stocks.
If we zoom in on the current correction, it appears that NOVA is setting up for the final drop in this correction. A move below $186 will confirm this as we target $152 – $138 for our first entry. If NOVA can instead hold $186 and then breakout above $230, we will be in the final swing of this 3rd wave. This stock has a lot to prove before we’d consider it a longer-term buy rather than a momentum stock.
Conclusion
Nvidia, TSMC, and Micron are bellwethers for AI accelerator, advanced packaging and HBM demand, with the three showing no signs of slowing any time soon. This will continue to create opportunities for growth in the metrology equipment market, as AI accelerator-related HBM and advanced packaging demand continues to grow and outstrip supply.
Metrology equipment is positioned well to capture the increase in complexity from advanced nodes, memory stacking and other chipmaking processes where demand is outstripping supply into the foreseeable future.
Onto and Nova share in these tailwinds, evidenced by accelerating quarterly revenue in Q2 and strong margins, cash flows and healthy balance sheets. We will be watching for further evidence that these companies are participating in the Ai boom in the upcoming quarters.
This analysis is a preview of what you can expect in our upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!
Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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