Chipmakers may feel fit at the moment, but if many analysts are correct, there's no reason to get excited about the companies that provide them manufacturing equipment.
Good news from semiconductor manufacturers such as Intel, Advanced Micro Devices and National Semiconductor has emboldened investors to push up shares of leading semiconductor equipment makers such as Applied Materials and Novellus Systems in recent weeks.
But analysts caution that it may be a little too early for big doses of optimism.
"Capital equipment stocks are back up to where they were six months ago," said Timothy Arcuri, analyst with Deutsche Banc Alex Brown. "But is the (technology) world much different than it was six months ago? I'm not so certain about that."
At the very least, demand is improving in the eyes of major chipmakers that talked about quarterly results last week.
Intel and AMD, the leading producers of PC processors, raised their sales estimates for the December quarter. National Semi, one of the top makers of communications chips, reported fiscal second-quarter revenue that was far better than observers had been predicting and said that sales in the third quarter--normally a slower period--would be about the same.
The news is undeniably good for chipmakers, but that doesn't necessarily mean much for the companies that make their machines. A smile from Intel doesn't immediately translate into more business for Applied Materials, Novellus, Tokyo Electron, KLA-Tencor and others, according to several analysts.
Chipmakers may be selling more chips than they were six months ago, but an improvement in sales doesn't always mean their plants are at full capacity--and it's capacity utilization that drives a large portion of capital equipment purchases. And it remains to be seen whether the December quarter's improved chip sales will be sustained.
Even though the demand picture for the chip equipment industry arguably hasn't changed for the better in recent months, shares of many providers of chip manufacturing equipment have been surging. Since Oct. 1, Applied Materials shares rose 65 percent; Novellus, 70 percent; KLA-Tencor, 92 percent; LAM Research, 59 percent; and Credence Systems, 81 percent.
Premature gains?
Many observers have been wondering if the gains aren't premature, especially since many chip executives have essentially written off the first half of 2002 as a stagnant or down period. Investors seem to be looking ahead to the year beyond, said Carl Johnson, president of Infrastructure, a chip market research firm.
"I find it quite interesting that people are valuing these things based on 2003 (earnings and revenue) estimates," Johnson said.
At the end of September, technology companies were so unsure about the future that many of them, including chipmakers, cut their public forecasts as much as they could. "Given where the economy was, it would have been hard for them to stick their necks out much farther," Johnson said.
For instance, the median analyst estimate for Applied Materials calls for a loss of a penny per share in the company's fiscal first quarter, according to earnings tracking firm First Call. For the year, analysts predict a profit of 21 cents per share--an 81 percent drop from the previous fiscal year. First Call consensus predicts a fiscal 2002 decline of 36 percent in Applied's revenue.
Estimates of chip demand were so low for the last three months of 2001 that several Wall Street observers thought raised forecasts were inevitable as the quarter progressed.
"What Intel said is largely what I and many others expected them to say," said Arcuri, who summed up his view in the title of his latest research note, "Our Thesis Unchanged."
Many investors realize that the expectations bar for the chip industry is unusually low, which could explain why the Nasdaq composite index slid 1.6 percent Friday despite the raft of upbeat news from the chip sector. "In recent sessions, more Wall Street technology analysts and portfolio managers are willing to openly acknowledge that expectations are low," said Arnold Berman, chief strategist for SoundView Technology Group. "And that most of the news of late has been good."
However, Berman has been bullish for the last few months. So has Tia-Min Pang, SG Cowen Securities analyst for semiconductor capital equipment.
"I don't think it (chipmakers' good news) should be underestimated," said Pang, who believes equipment orders will be increasing by the end of March.
Pang's argument largely stems from the fact that the biggest chipmaking subcontractors, Taiwan Semiconductor Manufacturing Co. and United Microelectronics, have reported that their percentage of manufacturing capacity being used has risen "dramatically" in recent months. Foundries are usually the first to feel changes in the chip cycle, Pang said, adding that those companies are starting to order new machines.
He admits he's in the minority as a near-term optimist. Like Arcuri, the majority of industry watchers don't expect the chip-capital equipment sector to recover strongly from the recession until the second half of next year at the earliest.
Even if chipmakers' business continues to improve, it will take at least a few months for that effect to be felt in the form of new orders for manufacturing equipment orders.
And most chip plants are still far from using their maximum capacity, Johnson said. Even though unit volumes and prices have improved for many parts of the chip industry over the last few months, reports for the current quarter mean little in predicting next year, he said.
"More telling will be what happens in the first quarter of next year," Johnson said. "I read (last week's chip reports) as a positive, but I also am concerned about the post-holiday selling season."