GS US Semi Equip Weekly - NVLS and
CMOS Previews and updated short interest
data
Summary: (1) Novellus hosting a mid-qtr update on Tues.; while the Street expects
Novellus to raise its order guidance, we believe it is more likely that order guidance will
be unchanged. Either way, we continue to expect orders to decline for several more
quarters vs. the consensus view that orders will accelerate in H1'05, (2) Credence
reporting on Weds.; we believe the magnitude of the expected losses that the company
will incur early in the downturn calls into question the health of the back-end segment, (3)
Short interest up slightly m-m in Nov.; short interest remains well below peak levels from
last cycle and we would expect it to increase in the coming months as the seasonal beta
trade ends and hopes for an abbreviated downturn diminish, (4) SIA Q3 capacity
utilization data show increases in fab capacity and the first q-q downtick in utilization
rates this cycle, (5) Goldman Sachs is hosting a Semi/Semi Equipment bus trip in Boston
on Weds., Dec. 8th, and (6) News, events and price performance.
NOVELLUS SYSTEMS IS HOSTING A PREVIOUSLY SCHEDULED
MID-QUARTER UPDATE CALL ON TUESDAY EVENING; WHILE THE STREET
EXPECTS THE COMPANY TO RAISE ITS ORDER GUIDANCE, WE BELIEVE IT
IS MORE LIKELY THAT MANAGEMENT WILL LEAVE ITS ORDER GUIDANCE
UNCHANGED. EITHER WAY, WE CONTINUE TO BELIEVE THAT ORDERS
WILL CONTINUE TO DECLINE FOR SEVERAL MORE QUARTERS IN
CONTRAST TO CONSENSUS VIEW THAT ORDERS WILL ACCELERATE IN
H1'05. WE CONTINUE TO RECOMMEND THAT INVESTORS AVOID THE
STOCK. Novellus Systems is hosting a previously scheduled mid-quarter update
conference call on Tuesday after the US market close. We are modeling Q4 revenues of
$320 million (-23% sequentially) with EPS of $0.19, vs. the Street consensus EPS
estimate of $0.21. We are modeling EPS on the low-end of the company's guidance range
as we believe that the company's implied gross margin and operating expense guidance
for the quarter are aggressive, as despite the significant sequential decline in revenues, it
implied flattish gross margins and significant reductions in expenses. We forecast Q4
shipments of $325 million, vs. management guidance for shipments of $315 million to
$330 million.
While Street expectations call for the company to raise its guidance for an approximate
23% sequential decline in CQ4 orders, we expect the company to leave its order guidance
essentially unchanged. Our checks indicate that business conditions remain challenging
with the exception of continued orders from the DRAM makers which we expect will
begin to decline over the coming months. Further, Applied Materials highlighted on its
earnings call about a week and a half ago that business conditions had deteriorated in the
last 30 days of the company's quarter. Even if Novellus had the ability to slightly raise its
guidance based on some orders that could be placed either in Q4'04 or Q1'05, we fail to
understand why management would raise order expectations in light of the difficult
fundamental environment. Most importantly, while the market is likely to focus its
attention on the company's commentary around the current order environment, we are
significantly more concerned with the fact that business conditions are likely to continue
to deteriorate for another several quarters based on our fundamental supply-demand
work, which shows continued imbalance for the next several quarters.
Regarding valuation, the stock looks expensive on both book value and normalized cash flow
metrics. Novellus has approximately $10 in tangible book value per share and has troughed at an
average of about 2x book value during the last several downturns, which would imply a trough
price of about $20 vs. the current stock price of approximately $28. Relative to normalized metrics,
we estimate that NVLS will generate about $0.65 in normalized cash flow over the course of the
full cycle (2003-2006), which would mean that the stock is trading at between 40x and 45x
normalized cash flow, a significant premium to the broader market multiple for a stock in an
industry that has grown at a 1% CAGR over the last two cycles and that is seeing significant
margin erosion over the course of the cycle. We recommend that investors continue to avoid the
stock, as we believe that the market will abandon its belief that the current downturn will be short
and shallow as we expect fundamentals to continue to disappoint for another several quarters.
CREDENCE SYSTEMS IS REPORTING EARNINGS ON WEDNESDAY; WE BELIEVE THE
MAGNITUDE OF THE EXPECTED LOSSES THAT THE COMPANY WILL INCUR SO
EARLY IN THE DOWNTURN CALLS INTO QUESTION THE HEALTH OF THE
BACK-END SEGMENT. Credence Systems is reporting its October-quarter earnings on
Wednesday after the US market close. Recall that the company negatively preannounced its
earnings results back in early October, indicating that sales were expected to be between $110
million and $115 million with a LPS of -$0.17 to -$0.21 (including the impact of amortization) vs.
earlier guidance for sales of between $140 million and $150m and EPS of $0.05 to $0.10. We
forecast revenues of $115 million with a LPS of - $0.11 excluding the impact of amortization and
an LPS of -$0.17 including the impact of amortization, vs. the Street consensus LPS estimate of
-$0.18 (which includes the impact of amortization).
We are modeling a 24% sequential decline in October-quarter bookings to $125 million (recall that
the company doesn't provide explicit order guidance). We believe that business conditions in the
back-end segment remain weak, as both the IDMs and outsourced package and test houses are
correcting for the excess test capacity that they built during the upturn. We would note that the
SEMI book-to-bill data released last week highlighted another 17% month-over-month fall-off in
back-end bookings in October. We expect order weakness to continue in the back-end for another
several quarters, so we would expect management commentary around the current fundamental
environment to highlight continued weakness even though the company doesn't provide explicit
order guidance.
We believe that the magnitude of the loss that the company is incurring in the first quarter of the
current downturn calls the health of the entire back-end test segment into question. Further, we
would note that the company generated only $0.26 in cumulative earnings (meaning over the
course of the entire recent upturn) and will lose nearly as much in only the first quarter of the
current downturn. While management announced a facilities restructuring plan to reduce operating
expenses during the quarter, we believe that consolidation in the back-end segment is needed to
improve the lack of profitability across the industry as the hyper-competitive environment has led
to significant pricing issues. Our secular and cyclical concerns regarding the back-end space,
coupled with what we believe are rich valuations (CMOS has about $2.50 per share in tangible
book value and the stock troughed at 1x book value during the 2002 downturn, which would imply
meaningful downside risk from the current stock price of $8, and the company doesn't generate
earnings or free cash flow over the course of a full cycle), lead us to continue to recommend that
investors avoid the stock.
SHORT INTEREST UP SLIGHTLY M-O-M IN NOVEMBER WITH SIGNIFICANT
INCREASES IN SHORT INTEREST IN LRCX AND NVLS AND SIGNIFCIANT DECLINES
IN KLAC, AEIS, AND ACLS; SHORT INTEREST REMAINS WELL BELOW PEAK LEVELS
FROM LAST CYCLE AND WE WOULD EXPECT IT TO INCREASE IN THE COMING
MONTHS AS THE SEASONAL BETA TRADE ENDS AND HOPES FOR AN
ABBREVIATED DOWNTURN DIMINISH. Data released on Wednesday last week showed that
the aggregate short interest for the companies in our coverage universe increased slightly m-o-m
after exhibiting a modest m-o- m decline (-3%) in October. We would note that, while the aggregate
short interest in the thirteen stocks that we cover increased only modestly month- over-month in
November, short interest in LRCX and NVLS increased significantly while short interest in KLAC
decreased meaningfully. Specifically, LRCX short interest increased 16% month-over-month,
NVLS short interest increased 15% month-over-month, and KLAC short interest decreased 9%
month-over-month. We would also note that short interest in Applied Materials remained
approximately flat month-over-month.
Short interest remains well below the peak levels reached last year as many investors are either
understandably participating in the seasonal long trade and/or (less understandably in our opinion)
believe that this downturn is going to be much shorter and shallower than every other downturn in
the history of the industry despite data which would indicate otherwise. While composite short
interest (approximately 106 million shares short) in our stocks is well off of the cycle lows it
reached in May of 2004 (approximately 83 million shares short), it remains s
ignificantly below the highs it achieved in February of 2003 of approximately 144 million shares
short. As we have mentioned on several occasions, semi equipment stocks are inversely correlated
with the aggregate amount of short interest in the stocks in our coverage universe.
We would expect meaningful increases in overall short interest in the stocks in our coverage
universe in the coming months to drive the stocks lower as our fundamental work continues to
suggest that this downturn is shaping up to be more severe and is likely to last longer than current
Street expectations.
SIA CAPACITY UTILIZATION DATA OUT LAST WEEK SHOW INCREASES IN FAB
CAPACITY AND THE FIRST SEQUENTIAL DOWNTICK IN FAB UTILIZATION RATES IN
Q3. The Semiconductor Industry Association (SIA) released its Q3 fab capacity and utilization data
last week. 8-inch equivalent wafer start capacity increased 4% sequentially in the third quarter. We
believe the data support our contention that the industry has continued to build additional capacity
over the last several quarters. Recall that our normalized semi equipment shipment analysis
highlights that worldwide front-end semi equipment shipments remain above their trendline, which
means that the industry is adding excess manufacturing capacity. Front- end shipments need to trend
back below the trendline over the next several quarters for the industry to correct for the excess
capacity it is building.
The SIA data released last week also show that fab utilization rates downticked sequentially to
92.7% in Q3 from 95.4% in Q2. Q3 marks the first sequential downtick in utilization rates in five
quarters. Our industry supply-demand work highlights continued expected declines in utilization
rates in 2005 as significant semi equipment shipments that were made in 2004 continue to come
online and yield capacity at the same time that the industry corrects for the excess IC unit
inventories that were added to the channel during the upturn. Our work estimates an expected
decline in utilization rates in 2005 to the low to mid 80's.
GOLDMAN SACHS IS HOSTING A SEMICONDUCTOR AND SEMICONDUCTOR
EQUIPMENT BUS TRIP IN BOSTON ON WEDNESDAY, DECEMBER 8TH. We are hosting a
Semiconductor and Semiconductor Equipment bus trip in Boston on Wednesday, December 8th,
during which we will meet with ATI Technologies, Varian Semiconductor Equipment Associates,
Teradyne, MKS Instruments, and likely one other Semiconductor or Semiconductor Equipment
company. If you are interested in attending the bus trip, please contact us or your Goldman Sachs
sales representative.
News, Events and Price Performance
Last week
Monday 22 November (1) Amkor Technology commented that an Administrative Law Judge has
issued an initial determination that Carsem infringed some of Amkor's patent claims relating to its
MicroLeadFrame package technology. However, the judge did not find a statutory violation of the
Tariff Act, prompting Amkor to file a petition to have the judge's ruling reviewed by the
International Trade Commission. (2) Advantest Corporation announced the availability of its
T7722 mixed-signal tester. (3) Mykrolis Corporation announced that its board of directors elected
Gideon Argov as the company's new CEO, effective immediately. Argov was also elected to the
company's Board of Directors. Prior to joining Mykrolis, Argov served as Managing Director of
Operations at Parthenon Capital, a Boston-based private equity firm.
Tuesday 23 November (1) Asyst Technologies announced that Asyst Shinko (ASI), the company's
51%-owned joint venture with Shinko Electric of Japan, has resolved the customer contract
dispute, which caused the company to delay the reporting of its quarterly earnings results. The
company will file the FQ2 Form 10-Q as soon as possible but is not able at this time to determine a
certain date by which the form will be filed.
Wednesday 24 November (1) Mykrolis Corporation announced that included in the equity
compensation package granted to its newly elected Chief Executive Officer, Gideon Argov, was an
Employment Inducement Stock Option covering an aggregate of 225,000 shares which was granted
on November 21, 2004. (2) Axcelis Technologies announced that it will consolidate the
administrative offices and development and customer support operations of its Cleaning and
Curing product group, based in Rockville, Maryland, into its headquarters in Beverly,
Massachusetts. The company estimates that the move will reduce operating expenses by
approximately $5 million annually, the benefits of which will begin to be realized when the
relocation is completed in the third quarter of 2005. Management indicated that the estimated cost
of the consolidation to be incurred over the next three quarters is expected to be approximately $10
million. (3) Novellus Systems announced the introduction of ALTUS DirectFill, designed to meet
contact and via-fill needs at 65 nm and below.
This week's calendar:
Tuesday 30 November: (1) Novellus Systems (NVLS-$28; IL/C) hosting a previously scheduled
mid-quarter update call; GS $0.19; Street $0.21.
Wednesday 1 December: (1) Credence Systems (CMOS-$8; U/C) reporting earnings; GS -$0.11
(including the impact of amortization, GS -$0.17 excluding the impact of amortization); Street
-$0.18.
GS Universe Price Performance 11/26/04 Price performance
Ticker Company Name Rtg Close
Week MTD QTD YTD Y-Y Semiconductor Capital Equipment AEIS Advanced Energy U/C 9 1%
-13% -7% -67% -67% AMAT Applied Materials U/C 17 0% 6% 3% -24% -28% ATMI ATMI Inc.
IL/C 23 1% 0% 14% 1% 2% ACLS Axcelis Technologies IL/C 7 3% -16% -13% -30% -36%
BRKS Brooks Automation IL/C 16 2% 5% 10% -34% -35% CMOS Credence Systems U/C 8 2%
8% 13% -38% -37% ENTG Entegris IL/C 10 4% 7% 19% -23% -23% FORM FormFactor OP/C 25
-4% 7% 29% 26% -3% KLAC KLA-Tencor OP/C 46 -1% 0% 10% -22% -21% LRCX Lam
Research IL/C 27 -1% 2% 22% -18% -14% MKSI MKS Instruments IL/C 17 1% 7% 11% -41%
-38% NVLS Novellus Systems IL/C 28 2% 8% 5% -33% -35% TER Teradyne Inc. U/C 18 1% 6%
31% -31% -29% Mean -- -- 1% 2% 11% -26% -28% Median -- -- 1% 6% 11% -30% -29% Source:
Factset.
I, Jim Covello, hereby certify that all of the |
