Top Stories: Semiconductor
Equipment Makers Still Have a
Tough Road Ahead
By Eric Moskowitz
Staff Reporter
2/19/98 3:56 PM ET
In a setting better suited to the Royal Family than a
tech conference, the titans of the semiconductor
equipment and materials industry assembled
Wednesday to discuss their outlook for this year and
beyond. While New York's grandiose Plaza Hotel was
mighty impressive, Applied Materials (AMAT:Nasdaq)
CEO James "J.C." Morgan was clearly the main
attraction.
"We make the systems that make the products that
make the world," said Morgan, who has been at the
helm of the bellwether capital equipment maker for two
decades. Saying that the industry was getting over an
overdue correction, he argued that it was still in the
midst of a short-term "period of uncertainty" thanks to
the Asian contagion, with capital spending restraints
hampering continued expansion.
Morgan argued, however, that AMAT would weather
these problems as it continues to produce its latest
generation of manufacturing equipment that allow chip
makers to turn out chips with widths of just 0.25
microns. Already, these smaller chips make up 53% of
AMAT's sales, compared with 32% for its 0.35 micron
chip. Morgan made the persuasive argument that the
equipment and materials market had a similar period of
hesitation in late 1986, but overcame it quite nicely. "If
you invested $10 in our stock back then, it would be
worth $500 today," he said. In other words, we've
gotten through these kind of seemingly impossible
situations before, and we'll do so again.
Applied Materials, even after its move up from a low of
25 1/2 on Dec. 12 to its current 36, is trading at a
price-to-earnings ratio of 20. After pushing down Street
estimates for its latest January quarter, the company
beat First Call consensus estimates of 50 cents by 2
cents. And now that much of the bad news is behind
the stock -- analysts have lowered earnings estimates
from 50 cents to 38 cents for its April quarter -- some
believe AMAT can continue to lead this beaten-up
sector back to glory.
One thing's for sure: The entire sector has gotten an
AMAT-generated bounce over the last month. Many of
the bigger names -- including Novellus Systems
(NVLS:Nasdaq), Teradyne (TER:NYSE) and
KLA-Tencor (KLAC:Nasdaq) -- are up an average of
20% since mid-January.
These stocks still have a long way to go to match their
highs from mid-October, however. While the Nasdaq
Composite Index has nearly caught up to its October
peak, the major semiconductor equipment makers are
still significantly down from their highs. AMAT is down
29%, KLA-Tencor is down 40% and Novellus Systems
has fallen 33%. But now that many of the problems in
Asia have stabilized in this volatile sector for the most
part, analysts are starting to believe that this steep,
albeit short-lived, run can be sustained.
Jay Deahna, an analyst with Morgan Stanley Dean
Witter who rates Applied Materials a strong buy,
believes that after another round of preannouncements
in March, the sector can outperform the S&P 500 in
1998. (Deahna's firm has done underwriting for Applied
Materials.) His recent track record has been on the
mark: Deahna pounded the table for two stocks last
month just before the entire sector made its rapid move
upwards. One was ASM Lithography
(ASMLF:Nasdaq), which he backed at 65 and now is
trading at 78. The other was Cymer (CYMI:Nasdaq),
which was at 15 and now is at 20.
At the SEMInvest '98 conference this week -- put
together by the good people at Semiconductor
Equipment and Materials International -- analysts
argued over when exactly this beleaguered sector's
turnaround will be complete. Lehman Brothers
managing director Edward C. White, who lowered his
earnings estimates on AMAT Tuesday, said that the
industry is still suffering from excess capacity in
memory chips and an Asian slowdown in PC computer
sales, particularly in Taiwan.
Another problem is lower capital spending levels. The
Pacific Rim, which now contributes 14% of all capital
spending to the industry, up from just 6% in 1992, is
still hurting and hasn't been contributing as much to the
development of the industry as in years past. Also,
Japan, which contributes another 36% of all capital
spending, has not stepped forward to take advantage
of the weakness in Korean investment, and that could
lead to a sharp dropoff in capital investment in 1998,
say analysts.
"While the Japanese and Korean stories already have
been discounted, the falloff in Taiwanese spending on
new capital projects has not," said semiconductor
analyst Gunnar Miller, who is moving from
PaineWebber to Goldman Sachs this week. Miller
sees a 9% drop in capital spending worldwide in 1998
and Deahna believes there will be a 10% drop in
industry investment.
The analyst with the most positive view on the sector is
Elliott Rogers of Deutsche Morgan Grenfell. "I think
we are over the hump and that even after the sector's
move upwards this year, the industry still presents itself
as a good investment opportunity," he said between
SEMInvest '98 meetings. His favorites: "Right now, you
have to go with the best-of-breed players in this field,
AMAT and Teradyne." Rogers, a 1997 Institutional
Investor All-Star, was one of the first to select Teradyne
and he still thinks it has more momentum, thanks to a
strong fourth quarter that saw revenues jump 62%.
First Call estimates also call for a 76% rise in earnings
this fiscal year, which more than makes up for the
stock's relatively high P/E of 30.
While stock prospects seem to be improving, analysts
worry that the overall sector needs a best-case
earnings scenario to completely break out. "I don't think
we are going to see any change in their fortunes until
the sector's problems become more visible by the
middle of the year," White said.
So the short-term picture is still cloudy, but the sector's
long-term prospects are much improved from just two
months ago. Investors can expect one or two more dips
over the next couple of quarters and then a
broad-based move upwards as semiconductor
equipment leaders receive a new round of capital
investment. One caveat: If Asian economic problems
are still in the headlines by this summer, look for more
trouble out of this sector as the capital spending well
runs dry.
See Also
SECTOR FOCUS
How to Use
Sector
Analysis to
Pick Stocks
2/18/98 2 PM
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