From the pru:
EQUITY RESEARCH
VEECO INSTRUMENTS
NOVEMBER 23, 1998
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VECO: INVESTORS ARE GAINING CONFIDENCE IN 1H99 PC UNIT DEMAND, IMPROVMENT IN SENTIMENT SHOULD DRIVE MULTIPLE EXPANSION. RAISING PRICE TARGET TO $50
Subject: Veeco Instruments (VECO-40 7/8)--OTC SEMICO OPINION CURRENT: ACCUMULATEANALYSTS: JOHN W. PITZER (xxx) xxx-xxxx PRIOR: Risk: HIGH 12-Month Target Price: $50 --------------------------------------------------------------------------------Ind. Div.: -- Yield: -- Shares: 14.9 mil. 52-Wk.Range: 50-18--------------------------------------------------------------------------------EPS FY Year P/E 1Q 2Q 3Q 4Q Actual 12/97 $ 1.25Current 12/98 $ 1.04E 39.3X $ 0.31 $ 0.24 $ 0.26 $ 0.25ECurrent 12/99 $ 1.40E 29.2X $ 0.29E $ 0.33E $ 0.37E $ 0.41ECurrent 12/00 $ 2.00E 20.4X-------------------------------------------------------------------------------- Investment Highlights (1) Investor's perception of 1H99 PC unit and semiconductor demand is improving.(2) Improving sentiment should allow for further discounting and multiple expansion versus our 2000 EPS estimates.(3) Company fundamentals are improving modestly (reflected in our estimates) without significant near-term upside to estimates.(4) Veeco continues to be the dominant supplier of equipment to the data storage industry. Unique positioning, good growth prospects with GMR.(5) New 12 month price target of $50 up from $40; still significantly below September 97 high of $73. Discussion: We are raising our 12 month price target on shares of Novellus to $50 from $40. Our new price target is based upon multiple expansion as the demand environment for semiconductors and PCs is becoming more clear, with a positive bias for 1Q99. Recent upside surprise from Intel Corp. (INTC-$112,Accumulate by Hans Mosesman) as well as positive data points from PC and data storage industry should provide the basis for further discounting in the equipment group. During peaks and troughs of capacity cycles, equipment stocks do not tend to trade in conjunction with company specific fundamentals. Fundamentals at Veeco continue to track our expectation levels. Fundamentals at Veeco have bottomed and are showing modest improvements. Visibility and quote activity is improving from extremely low levels. We do not expect significant sequential gains in revenue and earnings over the next several quarters. Our estimates for 4Q98E are $50.5 million in revenue and EPS of $0.25, essentially flat with 3Q98 levels. Meaningful sequential gains in revenue and bookings is estimated for 2H99. Historically, as fundamentals bottom, investors begin to transition away from trough valuations towards earnings potential during the next growth cycle. Good technology exposure as industry migrates to MR and GMR heads should allow Veeco a quicker recovery path. There are technology trends in the data storage market where VECO is well positioned. Similar to the transition to 0.18, there is currently a transition in the data storage market from MR to GMR head types - the transition is being driven by the universal mantra of technology - smaller, faster, cheaper. This should allow Veeco to benefit in earlier 1999 as the industry migrates. In addition, the Company's markets continue to experience accelerating growth as Veeco finds new applications at each technology. Historically, the Company has addressed on the etch market. However, as the industry migrates to MR and GMR, the company has positioned itself to provide deposition and in-line metrology equipment. The data storage equipment industry may rebound more quickly than semiconductor equipment. The data storage industry entered into the cyclical downturn approximately 6 months before the SCE industry. In addition, the data storage industry did not add as much capacity during the growth years as the semiconductor industry did. Therefore, we believe that the data storage industry should come out of the spending downturn more quickly than the semiconductor industry. Valuation still shows upside potential, however, the stock is no longer a bargain. Over the last several weeks, stocks in our universe have reacted to positive investor sentiment that the semiconductor capital equipment industry is at the bottom of the current cycle. Historically, when the industry troughs and sequential revenue and EPS growth transitions from positive to negative, investors have been willing to forgo trough valuations and begin to value stocks versus earnings prospects in the next growth cycle. We have contended that valuations will begin to discount appropriately to earnings potential in 2000. We initiated coverage in October, our price target was based upon 20 times our 2000 estimate of $2.00 and our thesis stated that if when begin to see positive data points from the PC industry for 1Q99 we would expect multiple expansion. The former is beginning to occur, we are raising our price target to $50, 25 times our 2000 EPS estimate of $2.00. Range of valuations from the trough to the expected growth cycle. In the fall of 1996 as growth resumed in the industry, Veeco traded between 20.2 and 27.2 times 1998 earnings potential (1998 turned out to be a negative growth year for the industry). Today, Veeco is currently trading at the low end of that range. Our new price target of $50 represents 25 times our 2000 EPS estimate, nearing the top end of the 1996 multiple range. In addition, Veeco is one of only a few stocks in our universe which is still significantly below it all time high of $73 set in September of 1997. Current All Time High % Difference AMAT $39 $54 38% ATMI $18 $42 133% ESIO $29 $61 110% NVLS $52 $66 26% VECO $41 $73 78% Appreciation yes, bargains no. Typically, investors discount six to nine months ahead of an expected pick-up in sequential bookings growth. We are cautious that discounting this time around seems to be occurring more quickly and to a larger degree than in past cycles - however, an important characteristic of each successive cycle is higher trough valuations and more significant discounting out to growth portions of the cycle. At current valuations, while stocks still have room for appreciation, the margin for error has narrowed and stocks will be more vulnerable to the vagaries of day to day marginal news coming from the semiconductor and PC industries. As such, and as opposed to four to five weeks ago, we view these stocks more as trading vehicles than investments near-term.
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