SMARTMONEY.COM: Glory Days In Chip Equipment
By MONICA RIVITUSO
Smartmoney.com
NEW YORK -- IT'S A GOOD TIME to be a chip-equipment maker.
After hitting a low in 1998, the industry is in the throes of a bona fide upswing. New technology is being
developed and shipped, revenue is increasing, earnings per share are jumping and stocks are
percolating. These are giddy times.
Given all that, just imagine what a chip-equipment industry conference is like. The mood, to put it mildly,
is optimistic.
Industry players gathered this week for the fourth annual SEMInvest 2000, a conference on growth
trends and investment opportunities sponsored by Semiconductor Equipment and Materials International,
a global trade association.
The three-day conference, held in New York, served as a forum for company CEOs to tout their
companies while discussing the industry's outlook with analysts and investors. David Wu, a Wall Street
Journal All-Star analyst with ABN AMRO, summed up the mood best in his opening remarks on
Tuesday: "This is a year to be happy and don't worry."
Fortunately, this carefree quip can be backed up with some decent fundamentals. The success of
semiconductor-equipment makers is, unsurprisingly, inextricably linked to the chip industry. And right
now, with the growing demand for silicon-intensive gadgets and technology, chips are faring pretty well.
While the Semiconductor Industry Association is forecasting chip sales to increase 21% this year, 20%
next year and 12% in 2002, Wu sees an even more vigorous upturn. He expects chip sales to rise 40%
this year, 46% next year and then 25% in 2002.
And chipmakers, which spent $25 billion on chip equipment last year, should jack up that spending to
$41 billion in 2002, according to SEMI.
PCs still account for the largest share of semiconductor demand, but chips for communications and
consumer electronic devices have become the latest drivers in the chip market. The transition to chips
with smaller wires is also fueling the need for more advanced equipment. And as chipmakers start using
new materials, like copper, and larger wafers to cut chips from, the shift will require batches of new
equipment, all to the delight of the companies that manufacture these pricey machines.
The chip-equipment industry might not be as sexy as the Internet or B2B, but without these
sophisticated products, there would be no chips. It's a simple enough generalization, but the
manufacturing process behind chips is anything but easy. To use one analyst's analogy, making
semiconductors is a lot like baking a layer cake - a very flat one that has about 15 to 30 microscopically
thin layers. The complex process can involve more than 450 pieces of equipment and take longer than a
month to complete. And each time chipmaking technology changes (for example, when wires become
thinner, as in the transition to 0.18-micron line widths from 0.25 microns) new equipment must be
manufactured.
Investors and analysts look to the largest chip-equipment maker, Applied Materials (AMAT), to gauge
the industry's health. And here are a couple of quick facts about Applied that get your attention: Last
quarter, the company's new orders grew 49% sequentially to a record $2.36 billion, while earnings
increased 566% to 40 cents a share from the depressed 6 cents a share a year ago. As the last
presenter at the SEMI conference, Applied's CEO, Joe Bronson, gave a strong long-term outlook, given
the semiconductor industry's upturn and a strong economy. "The company is really running on all
cylinders at this time," he said.
OK, this is all great. But the enthusiasm swirling around the industry begs the question: Is everyone
getting a little too excited?
It's true that these stocks have been on an absolute tear. Applied shares rose nearly 197% last year and
are up 68.6% year-to-date. ASM Lithography (ASML)? That stock soared 273% last year and has
tacked on another 15.6% since Jan. 1. Likewise, Teradyne (TER) rose 211% last year and has risen
38.9% in 2000. KLA-Tencor (KLAC) shares saw a 156.7% pop last year and another 60.3% boost this
year.
P/E ratios are also a bit rich at first glance. Asyst Technologies (ASYT) and Etec (ETEC) have the
industry's highest, trading at 144.8 and 169.4 times this year's earnings, respectively. While these high
P/Es were the aberrations in a group of 41 chip-equipment stocks we sifted through using the Zacks
Research database, other companies also had high multiples. ASM Lithography trades at a multiple of
58. Applied at 47.8. And KLA-Tencor? It sports a P/E of 71.7.
But here's the counterargument. Seeing how this industry is characterized by extreme cycles, the PEG
ratios of these companies show a clearer picture. (PEGs, calculated by dividing a company's P/E by its
long-term growth rate, are helpful when trying to evaluate whether the prices paid for companies are
realistic, given their growth prospects.) Of the 41 chip-equipment companies we examined, only 26 had
P/E ratios that could be calculated. Of those 26, we eliminated the industry-high Asyst Technologies
and Etec Systems, because they skewed the results. The mean PEG ratio for the 24 that were left was
1.71.
When viewed on a price-to-growth basis, 11 of the 24 stocks actually have PEGs below the industry
mean. Notably, Novellus Systems' (NVLS) PEG is 1.36 - this, for a stock that rose 147.5% last year
and 56.5% this year. Even after Teradyne's run, its PEG is still only 1.6. And of the big names in the
group, Kulicke & Soffa (KLIC) has one of the lower PEGs. The stock might have risen 139.7% last
year and 83.2% this year, but it only has a 1.21 PEG. Granted, there were some companies with PEGs
that were higher than the industry mean. For example, KLA-Tencor, PIR Automation (PRIA) and
Brooks Automation (BRKS) have PEGs of 3.0, 2.72 and 2.26, respectively. But many were in the
neighborhood of 1.71, indicating that despite the fast-paced runup in many of these stocks, their future
growth supports those prices - even if they are bumping new highs on a regular basis.
Edward White, a Wall Street Journal All-Star from Lehman Brothers, says Wall Street has to start
looking beyond traditional metrics to evaluate many of these chip-equipment stocks. Comparing current
price performances to recent history doesn't necessarily work anymore. For one, today's upturn is
somewhat different. In the past, PCs were the name of the game in the semiconductor industry. But
now, sustained growth in telecommunications, the Internet and consumer electronics means there's a lot
more demand for chips - and chip equipment - out there. For that reason, White thinks the upcycle in
demand still has a ways to go.
But when should investors start worrying that the bottom is ready to fall out? When analysts or pundits
start pontificating about how all this new demand means the chip industry is going to be less cyclical. "I
think that's a bad sign called an 'exit' sign," jokes ABN AMRO's Wu.
For now, however, there's no need to rush out that door.
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