COMMENTARY-- Applied Materials shares continued to wilt this week after absorbing another in a steady procession of downgrades from leading brokerage firms.
This stock isn't going anywhere for a few quarters, but history shows that Applied can more than handle any short-term discomfort.
We've all heard in great detail about the trouble chip, PC and cellular phone companies are having and will continue to have in the next few quarters. But so far very little has been said about the semiconductor-equipment market.
That's about to change.
Analysts say there's a good chance that chip equipment spending will be flat to slightly lower in 2001. Not good news, but not all that bad considering the sector enjoyed about an 85 percent surge in 2000 to more than $30 billion.
Of course Applied (Nasdaq: AMAT) raked in the lion's share of those sales and despite the gloomy macroeconomic climate, stands to benefit one way or the other through this downturn.
Equipment orders, sales sure to decline
Applied officials will give the Street a better idea of just how slow sales will be in February when it announces its first-quarter results. Right now analysts are forecasting a profit of 75 cents a share on sales of roughly $2.8 billion.
Sources close to the company say orders in the quarter will be down about 10 percent, give or take a point, and the company will likely guide analysts lower in the next couple of quarters.
All this sets the stage for a robust recovery in the second half. With Applied shares hovering around $45 a share at a price-to-earnings ratio of 18ish, the question is, do you believe the stock will go much lower before it recovers in the fall?
Network equipment and telecommunications customers are still placing huge orders, just not as huge as they were six or nine months ago. Sales of video game units are also on the rise, giving Applied another healthy revenue stream.
"The main reason we're downgrading Applied now is that we're seeing a recession for the first half of the year," said Gerald Fleming, an analyst at Tucker Anthony Capital Markets. "It's only a matter of time before this slips over into the equipment industry."
Last week, Fleming cut the stock to a "market perform" rating from a "strong buy," largely in response to the flood of profit warnings from the likes of Intel (Nasdaq: INTC), Micron (NYSE: MU) and Advanced Micro Devices (NYSE: AMD).
However, this downturn presents some interesting opportunities for Applied and its investors.
Making the best of a bad situation
"Applied has a lot of cash, roughly $4 billion, and a strong balance sheet," said Chris Chaney, an analyst at A.G. Edwards. "It wouldn't surprise me to see them go into an acquisition mode."
Surely Applied could find some company, perhaps an inspection equipment maker such as Rudolph Technologies (Nasdaq: RTEC), to round its already formidable product line.
This downturn in information technology spending makes smaller chip equipment companies, trading at 50 percent or more below their 52-week highs, even more enticing.
Sue Billat, Robertson Stephens' chip equipment analyst, maintained her "strong buy" rating last month but did lower her fiscal 2001 earnings estimate to $2.89 a share from $3.29 while slashing her sales target from $12.57 billion to $11.46.
"We note that most chipmakers are reviewing their 2001 capital budgets, which we believe are still very much in flux, as visibility remains low," she wrote in a research note. "In our experience, Applied Materials has a track record of making market share gains during downturns and achieving high levels of profitability during upturns. In 2001, we expect the company to continue in this vein."
Lehman Brothers strategist Jeffrey Applegate is high on Applied as well, naming it along with BEA Systems (Nasdaq: BEAS), America Online (NYSE: AOL) and JDS Uniphase (Nasdaq: JDSU) as his firm's top picks for 2001.
After the predictable decline in orders for the next few quarters passes, Applied will be positioned to capitalize as chipmakers shift to more 300mm and sub-micron processes. Any acquisition bargains would be icing on the cake.
Semiconductor Equipment and Materials International (SEMI), the global trade association for the chip equipment and flat panel display industry, might have been a bit optimistic about growth in 2001, calling for sales of wafer process equipment to improve 24.1 percent to $38.7 billion this year.
The trade group made that prediction back in early December, well before anyone recognized the magnitude of this economic slowdown.
But even if chip-equipment sales fall 10 percent for the year, we're still talking about $27 billion to $28 billion in worldwide sales.
"When the equipment market comes back, Applied's going to be the stock to own," Fleming said. "It's the Mercedes or Lexus of the industry."