Still too early to be aggressive semi-equipment names

Recently, semiconductor and semi-equipment stock saw a nice rally. Sox has been lagging the market in the first half of this year. As the market advance has been largely driven by energy, commodity, industrial, and large conglomerate names, semi and semi-equipment names are seeing some catch-up action on the street. Traders are betting that with nice rebound on manufacturing and consumer sector, semi business will see robust second half pick-up. Also new consumer devices such as Apple iPhone may spur growth in the flash memory market and stabilize the price erosion that flash market has seen in recent times.

While tech names in the communication infrastructure area could rebound nicely in the second half, I still have doubt of robust recovery in the second half of this year for semiconductor sector. My contacts in flash memory market continue to tell me about very cautious environment in this segment, even in the second half of this year. DRAM market is in the midst of doldrums. With Vista operating system being the bust, DRAM market may continue to struggle, lacking corporate consumers who are willing to upgrade to the new operating system and new computers. Samsung has recently converted a lot of DRAM capacity into flash memory production. This is not to be interpreted as improving market condition in the flash memory but as extremely bleak DRAM market and cut-throat pricing pressure. Extra flash capacity now will saturate the flash market even more and could further erode the flash memory price.

With overall memory market still in anemic condition at best, I see no reason why Taiwanese, Chinese, and Korean chip foundries will buy any chip equipment in the second half of this year. I have been told that Samsung has depleted large amount of company cash reserve due to brutal memory pricing environment and more aggressive capital investment compared to other companies in Asia in the first half of this year. Consequently, Samsung could substantially tighten its spending belt in the second half.

That is not to say that flash memory market will not improve in the second half of 07. iPhone could be a big hit and we could see reaccelerated flash memory demand. However, given some semi and many semi-equipment stocks such as AMAT, LRCX and KLAC are trading at near 52 week high, earning expectation may turn out to be a little too aggressive. I think it may not be too prudent to jump into these names now. I would wait for one more pullback and would exercise extreme discipline about the entry price to buy these names. In summary, current strength could last. However, I would be a seller into strength and look for better entry point for these names.

I have added some comments from notablecalls about the state of the DRAM market below.

DRAM equipment space: real-time pushouts of tool shipments

Citigroup comments on the DRAM equipment space noting pushouts of future orders now appear to be giving way to real-time pushouts of tool shipments. Checks suggest ProMos - a Taiwan DRAM maker that has recently placed big orders (~30k wsm (wafers/month), or ~$1B+) in 1H:07 - is pushing out delivery on roughly half of these orders. Based on firm's calculations, these pushouts impact total industry tool shipments by ~5-10% in CQ3, putting more pressure on consensus EPS estimates that they feel are as much as ~20-25% too high in 2H:07 and C2008.

While all suppliers are impacted, it appears impact is greatest at AMAT, LRCX - both of which have big Taiwan DRAM exposure.

Citi notes they have been on the road the past few wks speaking with a broad base of investors. The general rhetoric remains cautious - yet incredulous that stocks have remained resilient in the face of "bad news". While there has been a lot of market speculation around capex cuts, there is frankly yet to be much in the public domain regarding pushouts, capex cuts, or the like. Firm thinks it all comes down to the numbers - and equipment stocks are simply not cheap enough to tell them that the buy side's EPS estimates are that much less than the sell side's estimates.

Indeed, major equipment stocks trade at roughly a market multiple off C2008 EPS - hardly discounting a big EPS cut for a cyclical group with a slowing growth profile.

Notablecalls: The DRAM space is a mess. During the past five months, the price of 512Mb has fallen to $1.80 from $5.80 (an almost-70% decline). The DRAM makers are bleeding from their eyeballs and slashing capex should not come as a surprise. Vista continues to be a disaster, so no help coming from there.

Citi's right pointing out the resilience of the semi equipment space in face of bad news. For example, AMAT's has climbed back to the levels where it was before reporting its terrible qtr in mid-May. I have to agree with Citi here - eventually, it all comes down to the numbers.

Sitting at my old desk I would put out a short line in both AMAT and LRCX here. Tight stops just above recent swing highs. Not looking for a home run here. Just some downside.

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