Here are the Merrill comments:
___________
Investment Highlights:
• We are reducing our intermediate term ratings on the shares of the passive component makers we follow – AVX (AVX--$23.88—B:1:1:7 to B:3:1:7), KEMET (KEM--$23.25—B:1:1:9 to B:3:1:9) and Vishay Intertechnology (VSH--$25.88—C:1:1:9 to C:3:1:9) – from Buy to Neutral.
• Up until now, our positive intermediate term ratings have reflected our belief that we would be able to continue to raise our EPS forecasts in coming quarters as sales, orders and profitability have exceeded our most optimistic expectations.
• We now think we are entering a period where estimates for the next three months and beyond are at risk.
• Therefore, we think share price performance for these three stocks could be limited over the next few quarters despite relatively attractive valuations on our new forecasts.
• We think investors with a long term time horizon (say 12-18 months) should find attractive entry points for all three stocks in coming months based on our expectations that EPS declines over the next twelve months will not be
as severe as the last downturn. Our long term ratings remain Buy.
Fundamental Highlights:
• We expect order growth to stabilize and even decline on a sequential basis as excesses caused by a mismatch of components at OEMs and EMS providers are worked off over coming quarters.
• We now think the tight supply environment may be unraveling a little quicker than we previously anticipated, which does not bode well for pricing relative to our previous expectations.
• We have become much more concerned that the short supply of tantalum powder could make EPS growth even more challenging during 2001.
• We are reducing our EPS projections for the next calendar year and would not be surprised if these new estimates still prove somewhat too optimistic.
Still, our view for 2001 is much more benign than the last downturn.
• We think current record levels in operating margins reflect not only the recent effects of an extremely favorable pricing environment but also a favorable shift in each company’s sales mix, which should continue.
Additionally, AVX, KEMET and Vishay now boast the most outstanding balance sheets in the years we have been following the companies.
Next Year Is Looking More Challenging …
We are reducing our intermediate term ratings on the
shares of the passive component makers we follow --
AVX, KEMET and Vishay Intertechnology – from Buy to
Neutral. Up until now, our positive intermediate term
ratings have reflected our belief that we would be able to
continue to raise our EPS forecasts in coming quarters as
sales, orders and profitability have exceeded our most
optimistic expectations. We now think we are entering a
period where estimates for the next three months and
beyond are at risk. We expect order growth to stabilize and
even decline on a sequential basis as excesses caused by a
mismatch of components at OEMs and EMS providers are
worked off over coming quarters.
We are reducing our EPS projections for the next calendar
year and would not be surprised if these new estimates still
prove somewhat too optimistic. Therefore, we think share
price performance for these three stocks could be limited
over the next few quarters despite relatively attractive
valuations on our new forecasts. Our revised outlook is
based on two major concerns that were significantly raised
after our trip last week to Electronica, which is a major
electronics industry trade fair, in Munich, Germany.
First, we now think the tight supply environment may be
unraveling a little quicker than we previously anticipated,
which does not bode well for pricing relative to our
previous expectations. Although, we think large case size
tantalum capacitors are still difficult to procure, we would
not be surprised to see availability become easier across a
wider range of products next year. Our field checks with
EMS providers and component distributors (around two-thirds
of demand for these companies), which have buoyed
our ratings in recent months, continue to find supply tight
but as this mismatch situation is altered, this environment
could change.
Secondly, we have become much more concerned that the
short supply of tantalum powder could make EPS growth
even more challenging during 2001. This is especially a
concern since profitability levels and pricing power for
these three cyclical growth companies have never been
better, thereby making comparisons particularly tough next
year. We continue to believe that these companies will be
successful in passing through a significant amount of the
tantalum powder price increases (around 40% year-over-year)
that must begin to be absorbed on January 1 st .
However, capacitor prices have reached such high levels
that we believe capacitor makers will be forced to
seriously consider the threat that OEMs will begin to seek
out alternative solutions for the next design cycle in their
pricing strategy. These alternative solutions could include
high end aluminum capacitors or capacitance solutions
embedded in printed circuit boards. Another potential
solution is niobium capacitors that EPCOS (EPC--$
80.75—B:1:1:7) is developing. These threats could
somewhat limit pricing power next year.
Our view for 2001 is much more benign than the last
downturn. We think unit demand will be at least on par
with average historical rates (18% on average for
tantalums and 25% for multi-layer ceramics), prices will
decline more in line with historical levels (5-10% per
annum) and that recent capacity additions in the industry
have been much more prudent. Prices have already risen
by an order of magnitude of about 20% in recent quarters
vs. traditional annual declines of 5-10%. We also expect
company managements to re-think capital spending plans
for next year. The net result is that we now expect AVX,
KEMET and Vishay to have negative EPS comparisons in
the second half of 2001 as margins narrow somewhat.
Table 1: EPS Estimate Revisions
AVX KEMET Vishay
Current Fiscal Year
Old $3.40 $4.20 $3.85
New $3.30 $4.05 $3.85
Next Fiscal Year
Old $4.00 $4.75 $4.30
New $3.00 $3.60 $3.55
Note: AVX and KEMET are on March fiscal years. Vishay’s fiscal year ends December.
… But Not A Disaster
The net of it all is we are not looking for disastrous
financial results next year, such as those experienced in the last downturn, which were especially harsh due to the
Asian economic crisis. We think current record levels in
operating margins reflect not only the recent effects of an
extremely favorable pricing environment but also a
favorable shift in each company’s sales mix, which should
continue. Specifically, all of the companies manufacture
more application specific (e.g., “specials”) or higher
performance products than in prior business cycles when
high volume, commodity products were much more
prevalent. Examples of improvements in sales mix since
the last downturn at each company include the following:
• AVX’s connector business (7-8% of sales) has
become more profitable and the company has
diversified further into tantalum capacitors from its
base in multi-layer ceramic capacitors. Tantalum
capacitors have increased from about 21% to around
28% of sales if we just compare full year F1999
(March) to the first six months of F2001. Meanwhile,
AVX’s high margin Advanced Products business
continues to account for 15-20% of sales and should
increase as a portion of sales in a slower growth
environment.
• KEMET has expanded its product offering through
joint ventures into high-end aluminum surface mount
capacitors and organic tantalum capacitors, which
should add tens of millions of dollars of incremental
sales, as the company expands upon its initial entry
into these product areas.
• Vishay has significantly reduced its exposure to the
capacitor and resistor market (65% of sales for the
first nine months of 2000) through recent acquisitions,
especially Siliconix (SILI--$32.25—No Rating),
which is maker of discrete semiconductors.
Also, previous cycles were much more PC driven whereas
in recent quarters, a wide variety of high end
communications end markets has become much more
meaningful. For example, today printed circuit boards that
are used for internet infrastructure equipment are more
important consumers of expensive larger case size
capacitor products.
Additionally, the last downturn, which is what most
investors remember as a typical downturn, was in fact a
confluence of events that we think would be very difficult
to replicate. Recall, that in 1998 the Japanese capacitor
makers, which typically serve Japan first and foremost,
had excess capacity as the Japanese economy was in
recession. Also, the Yen/Dollar relationship was much
more favorable for Japanese exporters. Finally, we think
worldwide demand for capacitors was growing at subpar
rates to the effect of the Asian economic crisis. As a
result, average selling prices declined at about 2-3X
average annual declines. |
