Industry Analysis
Apr 26, 1999
Semiconductors: Semiconductor Capital Equipment Industry Improving
Analyst: Chris Bulkey
The semiconductor capital equipment book-to-bill ratio for March improved for the sixth consecutive month, indicating that the industry is still in the early stages of a prolonged rebound.
The March book-to-bill ratio came in at 1.30, up from 1.21 in February, approaching the record peak of 1.41 set in February 1995. Based on the improving numbers one would expect to see a big rally among semiconductor capital equipment (SCE) stocks. This, however, has not been the case.
Prudential's SCE composite index of fifty stocks fell 5% during the week of April 12, ahead of positive earnings surprises from KLA-Tencor (NASDAQ:KLAC - news) , Novellus Systems (NASDAQ:NVLS - news) and Teradyne (NYSE:TER - news) . Weak earnings from Compaq (NYSE:CPQ - news) reignited concerns that personal computer (PC) sales could weaken throughout 1999. Since then, however, IBM (NYSE:IBM - news) reported strong numbers with no weakness in PC sales, while Gateway (NYSE:GTW - news) exceeded estimates giving no indication that PC demand is weakening.
All Eyes on Applied Materials
The catalyst to get SCE stocks rising will be second quarter earnings from Applied Materials (NASDAQ:AMAT - news) , which is expected to be announced on May 18. Analysts, in general, remain very bullish on SCE stocks believing that the industry is entering a prolonged recovery. BancBoston Robertson Stephens, in particular, has strong buy ratings on Applied Materials, Novellus and Teradyne.
Applied Materials' fiscal quarter earnings, for the period ended January 31, were $0.11 per share, nearly doubled the consensus estimate of $0.06 per share. The consensus estimate for Applied Materials' second quarter earnings is $0.25 per share, which would represent a 32% decline from the prior year's $0.37 per share, but would show a solid sequential improvement.
Aside from the company's propensity for exceeding expectations (earnings have surprised on the upside by an average of 117% over the previous three quarters) analysts have raised their full year 1999 earnings outlook headed into the release of second quarter numbers. Applied Materials, like a number of its counterparts that have already reported, should surprise on the upside.
One area of concern is the insider selling that has taken place recently. Since the beginning of March, insiders at Applied Materials have sold, or filed to sell, almost 800,000 shares. Insider selling is a bit worrisome, but considering that the shares have risen nearly 200% from their October lows, a bit of profit taking should not be alarming.
An article from Bloomberg News regarding insider selling at Applied Materials, notes that "most of the recent sales were options related." Since options have expiration dates, the resulting selling is a requirement for those who want to realize profits from their options stakes. There was similar insider selling at KLA-Tencor, Novellus and Teradyne prior to their positive results, which supports the notion that SCE stocks are not overvalued.
Another indicator that Applied Materials is not likely to disappoint with second quarter numbers is the steady decline in short interest this year. At the beginning of the year there were close to 15 million shares sold short. That has since fallen to a little more than 6 million.
As chipmakers continue to transition to smaller line-widths Applied Materials will be a big beneficiary due to its leading edge products. Concerns over PC demand and the sustainability of the improved book to bill numbers have caused the stock to essentially tread water since the beginning of February. As a result Applied Materials' shares are valued 29 times forward estimates, which will expand rapidly once investors become convinced that the recovery will last.
Bottom Line:
Applied Materials has positioned itself at the technological forefront of the SCE industry and remains our favorite stock in the group. Wall Street currently forecasts earnings to increase 94% in fiscal 2000, which will prove conservative if indeed the industry is entering a cyclical upswing, and all signs point toward that being the case.
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