GS US SEMI EQUIP WEEKLY: THOUGHTS
ON THE STOCKS AND 2005 ESTIMATES
Summary: (1) Semi Equipment stocks outperforming over last few weeks as investors
position themselves for a Q4'04 order reacceleration. We believe it's too early to be taking
positions based on Q4 orders, especially since we continue to get signs that Q3 orders are
flat to down q-q. We would recommend that clients wait to get more data before
speculating on the stocks based on Q4 orders, (2) Introducing our CY2005 earnings
estimates which we derive assuming a peak in orders in late 2004, (3) Credence to discuss
impact of NPTest acquisition on Tuesday, (4) No official announcement has been made,
but Samsung has likely increased its 2004 capex budget as we highlighted back in April.
Our bottom-up capex model now stands at +59% y-y for 2004. We are increasingly
concerned that significant capacity expansion in 2004 will negatively impact 2005 capex
as the semi equipment industry has never grown by more than 8% in the year following
capex of greater than +50%, and (5) News, events and price performance.
Semi equipment stocks outperforming over last few weeks as investors position
themselves for a Q4'04 order reacceleration. We believe it's too early to be taking
positions based on Q4 orders, especially since we continue to get signs that Q3 orders are
flat to down sequentially. We would recommend that clients wait to get more data before
speculating on the stocks based on Q4 orders. The semi equipment stocks have been quite
strong the last several weeks as many investors try to take advantage of a sector that was
beaten up earlier in the year. While we certainly understand the thought process behind
wanting to buy beaten up stocks, we are worried that investors are being too speculative
in their reasoning behind buying the stocks. Our intermediate-term view on the stocks
has, and continues to be driven by our normalized EBITDA margin thesis which leads us
to conclude that we are too late in the fundamental cycle to be overweight the semi
equipment stocks with a 6-9 month time horizon. We don't seem to get a lot of pushback
from clients on our 6-9 month view as most investors are comfortable with the idea that
the stocks will discount the end of the cycle by mid-2005. However, we are getting
tremendous pressure from clients to be more bullish on the stocks with a short-term time
horizon, mostly from clients looking to play the group for a trade into the seasonally
stronger data points which are likely to emerge over the coming months.
The short-term call in this group is always extremely difficult but the one thing that has
remained constant over the last several years is that the short-term trading direction of the
semi equipment stocks has traditionally been dictated by near-term order patterns. While
highlighting that we believe intermediate and longer-term investors are beginning to treat
this group more as a pure cyclical (which is our explanation for why the stocks didn't see
anywhere near the same trough to peak move as they had in previous cycles), short-term
investors are likely to continue to use order patterns to trade the stocks. To that end, we
believe investors are getting a bit ahead of themselves in wanting to buy the semi
equipment stocks for a trade today. Most importantly, the direction of CQ3 orders
appears flat to down sequentially with ACLS, ASML and, last Thursday, Novellus
management highlighting the possibility that CQ3 orders could be down sequentially,
albeit off of a higher base in CQ2. While many investors argue that flat to down CQ3
orders are in the stocks (we're not so sure about that) the more important argument is why
everyone wants to speculate that CQ4 orders will reaccelerate? To be clear, if CQ3 orders are down
sequentially (which looks possible/likely) and CQ4 orders are down again sequentially, then
investors who are buying the stocks for a trade today will lose money. There is no way anyone
knows what CQ4 orders look like today (most certainly that includes us) but with Q3 orders likely
flat to down, it puzzles us why so many investors want to buy the semi equipment stocks today
based on a Q4 order reacceleration. Our recommendation continues to be that investors should
wait for the data as we move into the summer so that we can make a fundamental case for the
direction of Q4 orders instead of just a hope or a guess.
A final point on the short-term call on the stocks, valuations don't support taking such a speculative
view on the fundamentals. As we have said many times, most stocks have at least 50% downside to
trough valuations which is where stocks are likely to go if down sequential Q3 orders is a trend
and not an anomaly. Based on our normalized valuation work, stocks are fairly valued, and fair
value this late into the fundamental cycle doesn't support taking an overly aggressive stance on the
stocks, especially given what could be 50% downside if fundamentals don't reaccelerate in CQ4.
INTRODUCING OUR CY2005 EARNINGS ESTIMATES WHICH WE DERIVE ASSUMING A
PEAK IN ORDERS IN LATE 2004. We are introducing CY2005 revenue and earnings estimates
for all of the stocks in our coverage universe except Credence Systems, as we will wait for greater
clarity on the company's financial outlook following the company's call on Tuesday to discuss the
financial impact of the NPTest acquisition (more on the close of the deal below). As the table
below highlights, our 2005 earnings estimates are slightly above the Street consensus for the
majority of stocks in our coverage universe. We would not believe, however, that the introduction
of above consensus earnings estimates has positive valuation implications for the stocks, as we
believe that pure cyclical stocks should be valued based on normalized free cash flow/earnings as it
best represents the what a company earns over the course of an entire cycle.
CY2004E CY2005E
GS Street GS Street
AMAT $1.10 $1.03 $1.45 $1.23
KLAC $2.00 $1.92 $2.80 $2.67
LRCX $1.15 $1.15 $2.15 $1.77
NVLS $1.10 $0.97 $1.85 $1.58
TER $1.50 $1.43 $1.50 $1.78
ACLS $1.15 $0.99 $1.00 $1.17
AEIS $1.35 $1.14 $1.55 $1.44
ATMI $0.75 $0.72 $0.85 $1.23
BRKS $1.42 $1.27 $1.65 N.A.
ENTG $0.50 $0.46 $0.60 N.A.
FORM $0.67 $0.64 $0.85 $0.87
MKSI $1.80 $1.59 $1.90 $1.62
Source: Thomson One, Goldman Sachs Research estimates.
We derive our CY2005 earnings estimates as follows: (1) First, we assume that semiconductor
capex will be approximately flat in 2005 from 2004 levels, as we believe that worldwide capital
spending in 2005 may be in the range of down 15% year-over-year to up 15% year-over-year with
the actual outcome depending primarily on the semiconductor industry outlook for 2005. (2)
Second, we assume that orders and shipments will roughly peak in late 2004. (3) Next we assume a
revenue peak in mid 2005. We believe that revenues will peak a few quarters after orders and
shipments peak due to SAB-101. Recall that SAB-101 is a revenue recognition accounting policy
that states that the equipment makers will generally recognize tool revenues upon customer
acceptance rather than shipment. This policy has typically resulted in about a two-quarter lag
between when a tool is shipped and when it is recognized as sales. The impact of SAB-101 can be
seen in the table below, which shows CY2003, CY2004, and CY2005 year-over- year revenue
growth actuals and estimates for the companies in our coverage universe versus year-over-year
industry-wide capex growth (based on our bottom-up capex model). Following two years in 2001
and 2002 of industry- wide capex declining by about 30% year-over-year, capex in 2003 increased
by about 14% year-over-year while revenues for the companies in our coverage universe increased
only 7% on average. We believe that while orders and shipments had begun to accelerate in 2003,
the revenue for a portion of that increase in shipments wasn't recognized until 2004. Note that we
are estimating an increase in revenues on average in 2004 of 64% while industry-wide capex is
estimating to increase by about 59% as a portion of shipments from 2003 begin to be recognized in
2004. Given strong capex in 2004, we would expect that shipments from 2004 will continue to be
recognized in 2005 despite what we expect to be approximately flat capex, thus driving our 14%
year-over-year revenue estimate for 2005 for the companies under coverage. (3) Finally, in deriving
our earnings estimates we assume that sequential revenue growth begins to decline in mid-2005.
Note that in some instances, companies will be forced to begin to pay a full tax rate in 2005 as
operating loss carry-forwards incurred during the downturn are expected to run out, which has a
negative impact on earnings in 2005 for those companies that were not recognizing significant tax
expenses.
Revenue growth (y-o-y % change)
CY2003A CY2004E CY2005E
AMAT -3% 87% 19%
KLAC -12% 52% 26%
LRCX 3% 68% 19%
NVLS 10% 47% 27%
TER 11% 55% 9%
ACLS 4% 102% 8%
AEIS 10% 88% 18%
ATMI 4% 13% 11%
BRKS 3% 87% 10%
ENTG 16% 40% 1%
FORM 25% 74% 22%
MKSI 7% 88% 4%
Average 7% 67% 14%
Capex growth 14% 59% 0%
Source: Company data, Goldman Sachs Research estimates.
CREDENCE WILL HOLD A CALL ON TUESDAY TO DISCUSS THE CLOSURE OF THE
NPTEST ACQUISITION AND ITS FINANCIAL IMPACT. Credence announced the closure of
the NPTest acquisition last week and the company will hold a conference call on Tuesday to
discuss the financial impact and details of the deal. Recall that the acquisition was originally
announced in February 2004 and was structured as a combined stock-for-stock and cash transaction
valued at approximately $660 million. Dr. Graham Siddall is expected to continue to serve as
Credence's Chairman and Chief Executive Officer, and Ashok Belani, President and CEO of
NPTest, is expected to assume the role of Vice Chairman of Credence. Mr. Belani is also expected
to join Credence's Board of Directors, along with Dipanjan Deb of Francisco Partners. John
Detwiler is expected to remain the CFO of Credence.
NO OFFICIAL ANNOUNCEMENT HAS BEEN MADE, BUT SAMSUNG HAS LIKELY
INCREASED ITS 2004 CAPEX BUDGET AS WE HIGHLIGHTED BACK IN APRIL. Last
week a press article indicated that Samsung is likely to make significant investments in its
semiconductor and TFT-LCD businesses over the coming years. Recall that after meeting with
Samsung in late April, we highlighted in our April 25th weekly that we believed the company was
likely to raise its 2004 capital spending plans. Prior to our April meeting with the company we
were modeling a total 2004 capex budget of $5.9 billion, including spending for memory, System
LSI, and TFT-LCD. Following the April meeting we raised our 2004 capex budget for Samsung by
$500 million to approximately $6.4 billion. There has not been an official announcement from the
company that it intends to raise its 2004 capital spending plan, but we believe that it is likely that
the company will announce an increase in-line with our $500 million estimate on its June
quarter-end conference call. Our bottom-up capex model now stands at +59% y-o-y for 2004. We
are increasingly concerned that significant capacity expansion in 2004 will negatively impact 2005
capex as the semi equipment industry has never grown by more than 8% in the year following
capex of greater than +50%.
News, Events and Price Performance
Last week
Monday 24 May (1) ATMI announced that ATMI Treatment Systems, its environmental abatement
equipment business, has signed an exclusive agreement with Metron Technology to handle product
sales, service, and support throughout Europe.
Tuesday 25 May (1) Ultratech announced that David Markle, Ultratech's chief technical officer,
was elected to the National Academy of Engineers.
Wednesday 26 May (1) Applied Materials and Praxair Electronics, a division of Praxair,
announced a joint initiative to provide fab commodity consumables services to semi manufacturers.
The commodity consumables services, which will be marketed by Applied Materials, offers a
one-stop shopping service for a range of generic commodity consumable items that are used to
maintain and operate wafer fabrication equipment.
Thursday 27 May (1) Novellus Systems (NVLS-$33; IL/N) hosted a previously scheduled
mid-quarter update call during which it left its Q2 order guidance essentially unchanged (the
mid-point of the guidance range increased to +11% sequentially from +10% sequentially), raised
its revenue guidance to $325 million to $335 million from $305 million to $325 million, raised its
shipment guidance to $360 million to $370 million from $340 million to $360 million, and raised
its EPS guidance to $0.25 to $0.27 from earlier guidance for EPS of $0.18 to $0.20. Please see our
5/27 note for additional details. (2) Varian Semiconductor Equipment Associates said that the
Boston Business Journal named it one of the top fifty Best Places to Work in Massachusetts.
Friday 28 May: (1) Credence System announced the closure of the NPTest acquisition. Credence
acquired all of the outstanding common stock of NPTest in a combined stock and cash transaction.
Each share of NPTest common stock outstanding was converted, directly or indirectly, into the
right to receive 0.80 of a share of Credence common stock and $5.75 in cash. All outstanding
options to purchase NPTest common stock were automatically converted into approximately 4.1
million options to purchase Credence common stock.
This week's calendar:
Tuesday 1 June: (1) Credence Systems will host a call to discuss the financial impact of the
recently completed NP Test acquisition.
Wednesday 2 June: (1) SEMI mid-year semiconductor and semiconductor equipment market
forecast update in Burlington, MA.
Thursday 3 June; (1) Intel mid-quarter update.
GS Universe Price Performance 5/28/04 Price performance
Ticker Company Name Rtg Close Week MTD QTD YTD Y-Y
Semiconductor Capital Equipment
AEIS Advanced Energy IL/N 15 12% 16% -25% -41% 33%
AMAT Applied Materials IL/N 20 9% 9% -6% -11% 35%
ATMI ATMI Inc. IL/N 26 7% 16% -3% 10% 12%
ACLS Axcelis Technologies IL/N 12 9% 15% 8% 17% 127%
BRKS Brooks Automation IL/N 21 17% 24% -2% -13% 93%
CMOS Credence Systems U/N 14 13% 26% 18% 6% 92%
ENTG Entegris IL/N 11 5% 11% -11% -12% 1%
FORM FormFactor OP/N 19 0% 7% -10% -5% N.A.
KLAC KLA-Tencor OP/N 48 8% 16% -4% -18% 14%
LRCX Lam Research IL/N 25 11% 14% 0% -22% 52%
MKSI MKS Instruments IL/N 23 14% 22% -3% -19% 33%
NVLS Novellus Systems IL/N 33 14% 15% 5% -21% 7%
TER Teradyne Inc. U/N 22 7% 9% -6% -12% 36%
Mean -- -- 10% 15% -3% -11% 45%
Median -- -- 9% 15% -3% -12% 34%
Source: Factset.
I, Jim Covello, hereby certify that all of the views expressed |
