Legg Mason May 2, 2005
Semiconductor Capital Equipment
Still Cautious, but Bottom is Near; Reiterate Sector Overweight Recommendation
------------------------------------------------------------------------------
Patrick J. Ho pjho@leggmason.com (214) 647-3509
All relevant disclosures and certifications appear at the end of this report.
* We spent time last week in Silicon Valley meeting with several of our
coverage companies and our contacts in the industry.
* We emerged from these meetings and conversations with no dramatic change in
our industry outlook.
* While a cautious tone is still prevalent near term, we believe that the
general sentiment is that the industry is approaching a trough.
* The question still remains when a recovery will exactly occur. We believe it
will be sometime in 2H05, with the December quarter likely representing the
first significant uptick in orders since early 2004.
* We believe that the sustainability of memory spenders throughout 2004 and a
return in foundry spending will be keys in ensuring our thesis plays out.
* Those companies that will outperform the industry will be ones that possess
dominant market share leadership or growth in their respective markets and a
favorable customer concentration.
* We reiterate our Sector Overweight recommendation for the space, while our
top stock selections remain Varian Semiconductor (VSEA, Buy, $37.29) in the
small/mid cap space and Applied Materials (AMAt, Buy, $14.87) in the large
cap segment.
Summary: We spent last week visiting with company managements and speaking with
our contacts in Silicon Valley following earnings season. The general consensus
is that the environment has not dramatically changed since early April,
although the sentiment still remains cautious in the near term. We believe that
this supports our thesis that the industry is nearing a fundamental bottom,
with a recovery scenario sometime in 2H05. As we have stated for some time now,
we believe that the June quarter will represent an absolute trough for the
industry. The question remains exactly when a recovery will occur, although we
suspect it will be sometime in 2H05. Conservatively, we believe that the
December quarter could be the period where the industry witnesses a large
sequential uptick in orders. We continue to reiterate our Sector Overweight
recommendation on the space, and we provide post-meeting updates on Applied
Materials, Lam Research, and Mattson Technology in separate notes.
Sustainability of Memory Spenders Remains Key: The March quarter has been
heavily tilted toward memory-related spending. While there has been some
feedback highlighting a slight lull in memory bookings over the past week to
ten days, we suspect that this is more related to the timing of orders being
placed. With many memory makers posting losses in the March quarter, we believe
that this facet has pushed back the timing of some shorter lead time equipment
orders and deliveries. We believe some capacity buys can be placed later in the
year when the environment improves. At this time, we do not believe that memory
spenders will cut capex plans. In fact, when examining the focus of memory
dollars, some of our contacts estimated that approximately 80% of these dollars
are targeted toward leading-edge capacity. This trend was supported by many
capex plans that were either reaffirmed or actually increased as these
chipmakers drive to get next-generation capacity in place as fast as possible.
We do believe that a major catalyst in the March quarter orders was flash
memory capex spending, particularly NAND flash capacity additions. However, we
expect DRAM capacity additions to continue throughout the year, particularly by
the likes of many second-tier DRAM suppliers, like Elpida, Powerchip and
ProMOS. As cash flow trends improve, we believe that these orders will be
placed sometime in 2H05. At this time, our feedback has been that there have
been no dramatic changes in customer behavior at this time.
When Does Foundry Spending Return?: The foundry group remains a big wild card
to the overall industry capex outlook for the rest of the year. While the
foundries have not changed any capex plans for 2005, in the near term, we
believe that they still remain cautious as a whole. Our feedback from our
various conversations support this near-term cautious tone. Although this
sentiment was prevalent in their respective March earnings calls, we are
starting to see a bottom for this group. While we had anticipated one more
quarter of a decline in utilization rates, most of the foundries are
forecasting flat to slightly higher percentages in the June quarter. Should the
industry experience normal seasonality, we believe utilization rates could
further improve in 2H05, increasing the foundries' confidence to spend capex
dollars. While not discounting the possibility that the foundries could pare
back spending plans, we could not garner any near-term data points on the chip
front which would lead us to take a more negative view. At this time, we do not
expect to see any major participation by the foundries in the June quarter and
still expect a bookings ramp sometime in 2H05 (which could be very back-end-
loaded this year).
Market Share Gains and Customer Exposure Separate the Outperformers: As the
industry continues to sort itself out over the next few months, we believe that
the outperformers will be those with market share leadership or growth, and
those that are favorably exposed to the biggest spenders in 2005. Varian
Semiconductor, in our opinion, represents one of the best examples of this
thesis, as it bucked the industry trends, delivering a positive outlook for the
June quarter. While Varian clearly is experiencing the same cautious spending
trends as its peers, it is benefiting from its tangible market share gains in
the high current ion implant space, and its exposure to both Samsung and Intel.
We expect this trend for Varian to continue in the near term and we believe
there is still significant upside potential when a recovery scenario takes
hold.
I, Patrick Ho, certify that the views expressed in this research report
accurately reflect my personal views about the subject securities or issuers; |
