Lehman's on the semi equip industry
Headline: Semiconductor Equipment: Slowing In Japan, Taiwan May Hurt EPS, But BUY!
Author: Edward C. White, Jr., CFA 1(212)526-4744
Company: AMAT, EGLS, KLIC, KLAC, ETEC, SFAM, TER, NVLS, LRCX, AEIS, PRIA
Country: IND CUS
Industry: SEMICO
Today's Date : 04/03/98
* As has generally been anticipated, the Japanese economy is slowing further, adversely affecting near-term business for semiconductor equipment companies. Recent preannouncements have highlighted this situation.
* The near-term fundamental pressure in the semiconductor equipment group is probably not over. Business in Taiwan may slow as well, and this is not factored into many Street estimates. Further preannouncements are likely.
* However, the market's focus is on 1999 EPS. Some equipment companies' shares have actually traded up on bad news announcements. There is no hope that 1998 will be a good year; attention has shifted to the next recovery.
* The drivers for the equipment industry in 1999 are likely to be (1) the need to upgrade badly outdated (i.e. 1995 generation) technology, and (2) the need to add capacity after a long period of low capital investment.
* We believe the industry's share price valuations may appear high on historical results, but they do not reflect the earnings potential in the next recovery cycle. We recommend purchasing selected equipment shares.
Highlights:
1. The table below shows some of the recent preannouncements of bad news by semiconductor equipment companies, and the subsequent share price performance. In the middle of 1997, any of these preannouncements could have caused a 20% or greater correction in the corresponding company' share price. For the moment at least, bad news on 1998 is being largely ignored.
Company (Rating) Preannounce Date Preannounce Px. 4/2 Close %Chg.
Advanced Energy (2) 3/05/98 AM $16.000 $14.938 -6.7%
Electroglas (3) 3/27/98 PM $15.500 $17.000 9.7%
KLA-Tencor (1) 4/01/98 AM $36.250 $40.500 11.7%
Lam Research (3) 2/12/98 PM $28.438 $31.125 9.4%
PRI Automation (1) 3/28/98 PM $26.156 $27.969 6.9%
Silicon Valley (3) 3/10/98 PM $24.000 $21.125 -12.0%
SpeedFam (1) 2/26/98 PM $27.375 $28.750 5.0%
Footnotes: A: Advanced Energy, FSI, SpeedFam. C: All companies.
2. We think there is growing recognition that the worse the industry climate is in 98, the better it may be in 99. By the end of '98 the industry will have been in a 3-yr. slump, for the first time in over three decades.
3. Chip industry capacity utilization is high. Semiconductor Industry Association data pegs utilization at 93% in the third quarter of 1997, up from 86% in the second half of 1996 (the last trough). There was nearly 95% utilization of advanced (sub 0.4 micron) capacity in the third quarter of 1997. Even with the Asian crisis, utilization of advanced capacity has remained high since Q3 1997. Another indication of high utilization is that an increasing number of major chip manufacturers are outsourcing a portion of their manufacturing to Taiwanese foundries (they are probably doing this to avoid having to add incremental near-term 0.50-0.35 micron capacity). Such outsourcing does not occur when industrywide capacity utilization is low.
4. Applied Materials estimates that the degree of excess DRAM capacity was just over 30% in '96 and just under 25% in '97, going to 12% in '98 and about 4% in '99. If this happens, there will be a need for new capacity in 1999.
5. The need for new technology will also be a driver in 1999. Consider the situation at TSMC, a major Taiwanese chip manufacturer. The company's capital spending program calls for modest growth in spending in 1998, and a modest decline in spending in 1999. But in 1997, only 23% of its capacity was for 0.35 micron and finer processing. This percentage will more than double to 47% in 1998, and will grow further to 65% in 1999. Many other semiconductor companies are going through a similar shift. This requires investment in new generations of equipment, but the benefit accrues only to those equipment companies that can derive a disproportionately large percentage of their revenue volume from equipment for processing 0.25 and 0.18 micron linewidths.
6. We continue to recommend purchase of Applied Materials (AMAT, $38 7/8, Rated 1), KLA-Tencor (KLAC, $40 1/2, Rated 1), SpeedFam (SFAM, $28 3/4, Rated 1), PRI Automation (PRIA, $27 31/32, Rated 1), Etec (ETEC, $61 3/8, Rated 1).
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Disclosure Legend: A-Lehman Brothers Inc. managed or co-managed within the past three years a public offering of securities for this company. B-An employee of Lehman Brothers Inc. is a director of this company. C-Lehman Brothers Inc. makes a market in the securities of this company. G-The Lehman Brothers analyst who covers this company also has position in its securities. |
