|Chip Equipment 21-Feb-01 08:41 ET [BRIEFING.COM - Robert J. Reid] |
In the game of Battleship, the point is to bomb your opponent's ships before yours are bombed. While you cannot see where your opponent's ships are, the more you bomb, the more you get the feeling that you're close. In the chip equipment industry, it's difficult to predict a bottom but here you can also get a sense that you are close.
Our Take on (the January BtB data)
The chip equipment makers trade in cycles. The stocks generally bottom 4-6 months ahead of the trough in orders. The risk is in predicting the bottom. For those not in the chip equipment stocks, Applied Material's recent guidance of a 30% decline in sales and bookings for Apr Q was a good sign that we are getting close to a bottom. Historically, chip equipment stocks trade strongly from the trough sequential sales quarter to their peak sequential sales quarter. For example, AMAT doubled from trough sequential sales in AprQ97 to AprQ98. From AprQ99 to JulQ00, the stock more than doubled from trough to peak sequential sales quarters.
So why invest in an industry with declining fundamentals? At current prices, we believe investors have already factored in weak January bookings and are expecting weak numbers for the rest of the first half of the year. As the year progresses, we believe investors are likely to look past the current downturn and focus on the next upcycle. Accordingly, we expect that many of these stocks are at or near their troughs.
Historically, orders have declined 60% peak to trough on average in past cycles. To date, orders have declined 37% in 3 months making it likely that the book-to-bill indicator is still on the decline. If history is any indication, orders should bottom in the September quarter. However, the decline in orders in this cycle is much faster and steeper than previous cycles. As a result, there is no guarantee that history will be repeated Since the market generally discounts 4-6 months out, the sector should begin to perform well in the relatively near future.
Also, we expect end user demand to improve in the second half of the year and 2002. Don't read as much into the slowing pace of PC sales to the chip space. While PCs make up a significant part of the market for chips, chip demand is becoming less PC-centric than in the past as more uses for chips materialize including communications, appliances and automobiles etc.
First, January may not be the bottom of the book-to-bill chart. Q1 and Q2. Given consensus expectations of a 15%-20% decline in chip equipment spending in 2001 coupled with the 30%-35% decline in bookings for Q1 guided by front end equipment companies such as AMAT, NVLS, and LRCX, there will likely not be a rebound in February and March as bookings are expected to decline further. Historically, the group has had false rallies at similar points on the book-to-bill continuum.
Second, the valuations on the stocks are not exactly bargain basement relative to past cycles. The front end equipment companies are trading at forward p/e's over 20x. While these are still lower than other tech bellwethers, they are still a bit high given the horrible industry conditions in the chip equipment space. With investors suddenly concerned about high multiple tech stocks, that's a potential concern. Third, lowered spending forecasts by the chip companies going forward could act as negative catalysts.
This is not a science. It's a bit of an art with some witchcraft thrown in. Our point is that it's tough to predict a bottom, but the data is getting pretty bad. If you're not in the sector, the more bad news, the better. How the stocks react today to the January data will be a key to gauging investor sentiment on how willing they are to overlook the expectation of continued bad news. Hopefully soon, investors will simply discount the bad news and not sell their holdings. When the group begins to hold up even in the face of bad data, that's the time to pick up the shares.
Bottom line, the sector is a good place to be for 12-month and certainly 18-month price appreciation. Could the stocks decline another 25%? Sure. However, it's a sector within the tech arena that will come back -- it's just a matter of time. People are beginning to realize that technology companies are cyclical. The outlook is bleak for the sector, but these stocks are not going out of business. They will be around a decade from now. While our favorites include NVLS, LRCX, KLAC, and KLIC, below are some additional chip equipment names to consider...