Chip-equipment stocks: Stars or stinkers?

Applied Materials, the world's largest seller of semiconductor equipment, already slashed its outlook for the quarter, driving the consensus estimate down to a profit of 33 cents a share on sales of $1.95 billion.

Before the company revised its outlook, analysts were forecasting a profit of 49 cents a share on sales of $2.4 billion. It will report its second-quarter numbers May 15.

While all the analysts following the chip-equipment sector agree that capital spending by chipmakers will bottom out in the next two quarters, there are divergent opinions about whether these stocks are good investments at this point.

Timing and luck are everything in this corner of the technology-investing universe. The challenge for investors is picking the best time to buy Applied Materials, Lam Research or Novellus Systems, stocks that are sure to regain their luster once the manufacturing boom returns.

On Tuesday, Wells Fargo Van Kasper analyst Susan Crossley upgraded Applied Materials from a "market perform" rating to a "buy" and raised her 12-month price target from $50 to $72 a share.

"The decline in microprocessor orders should begin to decelerate as early as June when capital utilization at chip fabs should reach a trough," she wrote in a research note. "There are also indications that Samsung, Applied's second-largest equipment customer, is about to resume placing orders after a four-month hiatus."

Two days after Crossley's upgrade, Tucker Anthony Sutro analyst Gerald Fleming downgraded Applied Materials, Lam Research and Novellus from "market perform" ratings to "underperform."

That same day, Novellus Chief Executive Richard Hill told analysts attending the Merrill Lynch Hardware Technology Conference that semiconductor plants worldwide are working at between only 30 percent and 80 percent of full capacity.

"I don't expect to see any uptick in bookings until the fourth quarter," he told Reuters. "It would probably take one to two quarters before you would then see our earnings start to head in the northerly direction."

Despite all the negative news, semiconductor-equipment stocks have made sharp gains in recent weeks, increasing between 15 percent and 25 percent each.

Much of that run-up can be attributed to chipmaker Intel, which reaffirmed its plans to spend $7.5 billion on capital equipment this year as it gears up for the inevitable recovery in the later part of this year.

However, Fleming points out that Intel has already ordered another 32 percent of its planned 2001 expenditures for delivery in the second quarter, suggesting that second-half spending will come to a screeching halt.

Texas Instruments, the leading seller of digital signal processors, cut its 2001 capital spending to $1.8 billion, with half of that already spent in the first quarter.

"Together with Motorola, which last week announced plans to cut spending to $750 million from $2.4 billion last year, these announcements appear to mean that the three largest domestic equipment buyers will probably reduce spending by 50 percent to 80 percent in the second half of 2001," Fleming wrote in a research report.

Michael O'Brien, an analyst at Wit SoundView, said that some analysts are playing a dangerous game by advising clients to get into chip and chip-equipment stocks now, assuming that their prices won't drop much more before business conditions improve.

"We are not fans of chasing these stocks, although the fundamentals in the electronics end-markets are beginning to look less negative," he said last month. "From our viewpoint, the rebound in capital spending for capacity purchases is still several quarters away."