Investors See Better Days for Chips
By Nick Olivari
NEW YORK (Reuters) - Tech stocks are still far from their all time highs, but money managers are already betting that better days lie ahead, at least for the semiconductor industry.
Optimistic that the move to faster chips, a drop in inventories and lower interest rates will stoke demand for new chips, money managers are buying semiconductor equipment makers like Rudolph Technologies (NasdaqNM:RTEC - news), up 60 percent so far this year, and Dutch-based ASM Lithography (NasdaqNM:ASML - news), up 22 percent.
Their assumption? Before chip demand even picks up, the companies that make equipment will see revenues and profits rise as companies like Intel Corp. (NasdaqNM:INTC - news), the world's No. 1 chipmaker, gear up for new production.
``People had built in that the economy was going to hell in a hand basket, and taking the semiconductor industry with it,'' said Alex Valecillo, a portfolio manager with National City Investment Management Co. which oversees $24 billion.
``Now they're thinking the Fed will help stabilize the local and global economies.''
Valecillo owns stock in KLA-Tencor Corp. (NasdaqNM:KLAC - news), a maker of monitoring systems for the chipmaking process, Novellus Systems (NasdaqNM:NVLS - news), a maker of wafer fabrication systems used to make chips, and bought Kulicke & Soffa (NasdaqNM:KLIC - news), which services chip assembly equipment and sells packaging to the chipmakers, six weeks ago.
KLA-Tencor and Novellus have gained 17 percent this year, while Kulicke has jumped 21 percent. In 2000, all three stocks fell, with Kulicke shares losing 47 percent last year.
One reason for investor optimism is the Federal Reserve's surprise 50 basis point cut on Jan. 3 and another half percentage point cut at a regular Fed meeting on Jan. 31.
Merrill Lynch technology strategist Steve Milunovich notes that in easing cycles in the last 20 years, tech stocks on average have risen 26 percent the first year compared with 11 percent for the S&P 500. The years under Federal Reserve Chairman Alan Greenspan have been especially generous, with tech up 45 percent in the twelve months following the first cut.
``People are looking and saying it's ugly out there, but three to four quarters out, semiconductor market growth will continue,'' said Valecillo.
EARLY IN THE CYCLE
But why buy the equipment manuafacturers over the chip makers when both types of stocks should benefit from increased demand for semiconductors?
Investors are ``looking for what may rise the most early in the cycle,'' said Haruki Toyama, an associate portfolio manager with Cambridge, Massachusetts-based David L. Babson & Co., which oversees $60 billion in assets.
Chipmakers have to buy the capital equipment before they can manufacture the next generation of chips, Toyama said, so equipment makers should see their revenues and profits benefit almost immediately from that spending.
And investors are willing to buy equipment makers even though the book-to-bill ratio, a measure of the general health of the semiconductor industry, declined for a fourth straight month in December according to Semiconductor Equipment and Materials International, an international trade association.
``The market is looking past the bottom in the current cycle, and to an upturn in spending by semiconductor makers like Intel and Texas Instruments (NYSE:TX - news),'' agreed Dan Cook, managing director at StoneRidge Investment Partners LLC, based in Malvern, Pa., which oversees $1 billion in assets.
Cook's current holdings include Applied Materials (NasdaqNM:AMAT - news), the world's largest maker of semiconductor manufacturing equipment, which is up 13 percent this year despite warning last month that fiscal first-quarter results will be below analyst forecasts; and Rudolph Technologies Inc. (NasdaqNM:RTEC - news).
Some of that increase in spending will stem from the need to buy new equipment as chipmakers move to shrink the size of circuits to 0.13 microns. The smaller circuit size reduces the distance the electrical circuit must travel, so the chip is faster and requires less power.
Still, not all portfolio managers are convinced that the equipment makers are the best place to put your money now.
Dan Veru, chief portfolio at New Jersey-based Palisade Capital Management LLC, which oversees $3 billion, said the chipmakers are a safer play until the outlook is more certain.
Though he is adding to holdings in equipment maker Amkor Technology Inc. (NasdaqNM:AMKR - news), up 36 percent this year, he's also been buying chip maker Cypress Semiconductor (NYSE:CY - news).
And even StoneRidge's Cook says recent gains may be too far, too fast. He sold holdings in KLA-Tencor after the stock rose 34 percent in January.
``They jumped too fast and there will be a pull back before another rally in the summer,'' Cook said.
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