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Upgrade sparks chip-equipment rally

Morgan Stanley's Jay Deahna was the little engine that could for chip-equipment stocks Thursday. In an upbeat report, the analyst told investors that semiconductor capital equipment express is now boarding.

CNET's Semiconductor Capital Equipment index was up 5.56 percent as Deahna predicted that chip-equipment stocks were ready for a sustained rally.

Deahna raised his rating on six companies to "strong buy" from "outperform," sending shares higher. Applied Materials (Nasdaq: AMAT) rose $2.86 to $53.90, ASM Lithography (Nasdaq: ASML) gained $1.40 to $26.44, KLA-Tencor (Nasdaq: KLAC) jumped $3.60 to $53.13, Lam Research (Nasdaq: LRCX) rose $2.51 to $30.49, Novellus (Nasdaq: NVLS) gained $2.40 to $53 and Teradyne (NYSE: TER) was up $3.51 to $39.76.

"The train has left the station," Deahna wrote in his research note, and if investors want to grab gains of 40 percent over the next 12 to 18 months, it's "all aboard."

Deahna is the latest analyst to check in with an attempt to sound the bottom for chip-equipment stocks. Deahna said he based his thesis on the following: earnings estimates cuts that are finished for most companies in the equipment industry; conversations with sell-side analysts who are eager buy the sector on weakness; and projections that the economy will begin to recover after a second-quarter trough.

Analysts have been divided over whether these stocks are good investments at this point, though most agree that capital spending by chipmakers will bottom out in the next two quarters. The debate has caused an inordinate amount of anticipation about the second-quarter earnings report from Applied Materials on Tuesday. The company is expected to report earnings of 33 cents a share on revenue of $1.9 billion.

"We believe the current rally is the beginning of the real deal," Deahna said. He noted that the semiconductor stock rally in January had obviously been a false start, since more profit warnings were on deck.

But the recent rebound in semiconductor equipment shares should be the beginning of a cycle, Deahna said. Intel (Nasdaq: INTC), the world's largest chipmaker, recently reaffirmed its plans to spend $7.5 billion on capital equipment this year as it gears up for a recovery later this year.

"Estimates are largely attainable in (the second quarter) because push-outs and cancellations have mellowed," he said. Following a stabilization in the next two quarters, earnings estimates will move higher in the December quarter and throughout 2002, Deahna predicted.

The analyst cautioned, however, that chip-equipment stocks will post a rocky recovery because it'll take about four months before the chip sector begins to see signs of revenue growth.

In a recent report on the technology sector, Credit Suisse First Boston analyst Mark Altherr also noted that chip stocks were poised to rally, based on the gains of the Philadelphia Semiconductor index.

Semiconductor stocks overall should be the first sector to recover, but "sales will not rebound to 2000 levels until 2003," Altherr said.