Heard on the Street:
Semiconductor-Equipment Shares Are Surging
On Investors' Optimism About Asian Recovery
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By E.S. Browning
Staff Reporter of The Wall Street Journal
As the anguish over Asia eases, investors have begun plowing money into a group of stocks that some analysts track as a bellwether: the semiconductor-equipment makers.
Equipment sales often pick up ahead of a semiconductor recovery. With investors anticipating a bottom in Asian demand, the equipment stocks already have surged 20% this year. Equipment makers helped lead the technology-heavy Nasdaq Composite Index to a record on Monday, although they and the index fell back yesterday.
Now a debate has sprung up. Are the equipment stocks back on track, possibly signaling a broader technology recovery? Or are investors buying too fast, putting the recovery at the mercy of the next bad news from Asia?
"I have gotten a lot more optimistic on the group," says Gus Richard, semiconductor equipment analyst at Hambrecht & Quist in San Francisco. He says he thinks the need to trim earnings estimates for companies such as Applied Materials are about over. This month, he upgraded Applied to a buy from a hold.
But Michael O'Brien, SoundView Financial's semiconductor-equipment analyst, says Japanese demand could disappoint investors this year. "My expectation is that things may get a little worse than people expect," he says.
The bull case is simple. Because Asian countries such as South Korea have become leading users of semiconductor-manufacturing equipment, the Asian crisis hit the equipment makers hard. Their stocks fell more than 40% in about two late-October weeks.
Orders and revenue have continued to slip since then. But, notes Prudential Securities semiconductor-equipment analyst Milind Bedekar, the equipment-company stocks tend to recover six to nine months ahead of an upturn in their actual business, often serving as a leading indicator for other technology stocks.
U.S. and European demand for semiconductors has remained strong, and most analysts are convinced that Asian demand will recover as well. Mr. Richard of Hambrecht & Quist sees U.S. equipment-companies' revenue falling 11% this year, followed by a strong recovery with 25% growth in the next three years.
That would make this the time to buy companies such as Applied Materials, Novellus Systems, KLA-Tencor and Lam Research.
Mr. O'Brien of SoundView says some investors are hoping that Japan will boost equipment purchases to expand semiconductor production and win back market share while Korean competitors are on their heels. "But there is enough uncertainty in the Japanese economy that I think caution will be the name of the game rather than aggressive investment," he says.
Mr. Richard notes that the equipment makers' stocks historically have bottomed at a price equal to one times trailing per-share revenue. This time, they appear to have bottomed closer to twice that figure and now trade at roughly three times revenue. He notes, however, that with inflation low, much of the stock market is trading at higher valuations than in the recent past.
And some analysts suggest focusing on specific niches. For example, semiconductor producers now can make more chips with existing machines, slowing their need for new machines. But any increased chip output still requires just as many testing machines to monitor quality.
So Mr. O'Brien prefers stocks of testing-machine makers, such as Teradyne. He also likes Etec Systems, whose equipment is used by companies that want to upgrade their lithography equipment without investing in entire new machines.
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DEFLATION COULD BE GOOD, or at least so says PaineWebber strategist Edward Kerschner. Wall Street these days is wringing its hands over the risk that price deflation could lead to recession and a market decline. In a report this week, Mr. Kerschner distinguishes between deflation caused by too much debt -- Asia's problem -- and deflation caused by advances in productivity and technology, which, he says, would be the U.S. case.
Mr. Kerschner says he doesn't expect outright deflation -- overall price declines -- just slowing inflation. But if deflation does occur, he says, it could be similar to a benign variety the U.S. experienced late in the last century, a period of economic expansion. The Internet and other electronic communications, he says, could do for this economy what the railroad did at the end of the last century.
Mr. Kerschner says that inflation's steady decline now supports a price-earnings ratio of 24 for the overall market, which would put the Dow Jones Industrial Average at 10000 by the end of the century. That would mark a 20% gain from here -- healthy, although behind the growth rates of the past three years. |
