Semiconductor Capital Equipment: Has the Train Really Left the Station?
Research Analyst: Christopher Conry (5/29/01)
Don't fight the Fed. Trust the power of liquidity. You must be in the market now, ahead of the eventual
recovery.
These are the themes that prevail among investors in technology stocks, as demonstrated by the recent rally of
the Nasdaq Composite, which has shrugged off poor corporate earnings reports almost on a daily basis.
Nowhere is this phenomenon more evident than in the semiconductor capital equipment industry -- an area
where analysts and investors alike look for clues that may signal a broad technology recovery.
Undoubtedly, the effect of five consecutive interest rate cuts should be significant in this sector, which thrives
on the availability of low-cost capital to spur healthy levels of equipment spending. It's also logical that the
forward-looking nature of the markets would discount much of the industry's recent drought.
However, in order to analyze the current state of affairs here, two primary questions have to be addressed:
Has the chip equipment industry, in fact, bottomed? And if so, how quickly will the industry recover?
An answer to the first question would require a look at the most recent industry data. According to
Semiconductor Equipment and Materials International (SEMI), an industry trade group, North American capital
equipment manufacturers posted orders totaling $711.3 million in April, based on a three-month average of
worldwide shipments. That's a 41% sequential drop from the March-ending figure alone.
In addition, the industry "book-to-bill" ratio, which compares new orders and product shipments, came in at 0.42
for the period - the lowest number ever recorded since the group began tracking the data in 1991. Essentially,
only $42 of orders were booked for every $100 worth of products shipped.
Although the results fell well below estimates, and signify that further sales erosion is likely, analysts argue,
conversely, that the overall industry climate has reached an overextended and unsustainable condition that
should at least stabilize from here.
We'll buy that. But what about the second question?
Most industry experts argue that the transition to new semiconductor manufacturing technologies is on the
verge of spawning another multi-year upcycle. This includes the move from aluminum to copper transistors
(lower power consumption and heat generation), from 200-millimeter to 300-millimeter silicon wafers (more chips
per wafer), and continuing shrinks in die size, which allow for larger number of transistors per chip.
But ultimately, a full cyclical reversal would require a return to health in the major semiconductor end markets.
Believe it or not, the semiconductor industry is still heavily dependent on chip sales for PCs -- a rapidly maturing
product that's taken its lumps over the past year.
Despite signs that the PC market is stabilizing, unit shipment growth will likely be flat for the year, with only a
modest improvement reasonably expected in 2002. Other important products, including cellular handsets,
communications equipment, and personal electronic devices, don't appear to be flying off the shelves, either.
It should be taken into account that Dell Computer Corp. (NASDAQ: DELL - Quotes, News, Boards) has
effectively started a PC price war that should translate to lower margins and tighter spending budgets among
the major boxmakers.
Management at Agilent Technologies Inc. (NYSE: A - Quotes, News, Boards) has made comments lately that
may be the most revealing about both the semiconductor equipment industry and leaner corporate information
technology (IT) spending habits.
Agilent, which makes equipment that tests 85% of the world's cellular phones, has experienced a sharp
slowdown similar to the semiconductor equipment pure-plays. In response to shrinking order flows and
ballooning cancellation rates, management has decided to indefinitely not buy new PCs and related desktop
electronics, limiting purchases to critical server, storage, and selective software upgrades.
This type of cautious spending may well keep the semiconductor equipment makers' largest customers - Intel
Corp. (NASDAQ: INTC - Quotes, News, Boards), Texas Instruments Inc. (NYSE: TXN - Quotes, News,
Boards), and others -- under tighter spending restraints going forward.
Overall, however, many names in the equipment group are in surprisingly good shape, and are using the lull in
business to prepare their operations for the inevitable shift to newer technologies. The situation could be
viewed as buying opportunity ahead of the next upcycle.
But at what valuations?
On average, the stocks in the group are trading at about double historical valuations during the trough of a
semiconductor cycle.
Applied Materials Inc. (NASDAQ: AMAT - Quotes, News, Boards), the most ubiquitous name in the group, is
trading at about 46 times the First Call/Thomson Financial consensus earnings estimate for fiscal 2002 (ends
October). Despite slightly above-average current fundamentals and an industry-leading market position, it's
hard to make a case for much in the way of near-term upside given the still-risky industry climate.
Novellus Systems Inc. (NASDAQ: NVLS - Quotes, News, Boards) is a bit more reasonably priced at 30 times
estimated 2002 earnings, but the corresponding P/Es of Teradyne Inc. (NYSE: TER - Quotes, News, Boards) ,
at 37 times , and Lam Research Corp. (NASDAQ: LRCX - Quotes, News, Boards) at 35 times, also appear
rich.
Longer term, we like KLA-Tencor Corp. (NASDAQ: KLAC - Quotes, News, Boards) and Asyst Technologies
Inc. (NASDAQ: ASYT - Quotes, News, Boards) , on the heels of yield-management tools and wafer protection
systems, respectively, that should benefit greatly from the shift to next-generation manufacturing techniques.
But KLA-Tencor's 56 times multiple on 2002 estimates isn't particularly appealing, though Asyst, at 26 times
next year's earnings, would be one to take a hard look at.
Moreover, anecdotal evidence suggests that money flows into these stocks are getting a bit sluggish, which
suggests the recent rally could soon encounter at least some resistance and probably a modest short-term
correction.
Bottom Line:
Although picking the bottom of a group of stocks is just as challenging as trying to determine the bottom
of the broader market, the semiconductor capital equipment industry appears ripe for a pullback. As a
result, a little bit of patience should provide investors looking for exposure to this business plenty of
opportunities to find more attractive entry points.
individualinvestor.com
AdvocateDevil |
