By Sam Stovall With the first faint glimmers of a recovery in chip demand, investors have bid up shares of the companies that make the gear needed to produce them. And that run-up has enabled the semiconductor-equipment industry to join the list of companies with top Standard & Poor's Relative Strength rankings. But S&P analyst Richard Tortoriello says while long-term growth prospects for this highly cyclical industry are solid, he believes stock prices in the group have already anticipated a recovery.
Tortoriello says semiconductor end-markets are showing signs of recovery: climbing prices for memory chips (from depressed levels), higher semiconductor wafer starts are on the rise, and high capacity-utilization rates for leading-edge chip designs (those with widths of 0.18 micron and below). However, overall capacity utilization at wafer-fabrication facilities (or fabs) remains anemic. Tortoriello estimates fourth-quarter 2001 capacity utilization in the high 60% range -- and is unlikely to improve to levels needed to spur significant equipment sales until late 2002 or early 2003.
For the chip-equipment industry itself, things are looking a bit brighter. In the three months ended January, 2002, the North American semiconductor equipment industry posted a book-to-bill ratio of 0.81 to 1, up from 0.77 in December, 2001, and the cycle low of 0.44 in April. (The book-to-bill ratio compares average orders to average sales. When the ratio is above 1.0, orders exceed sales, and sales are likely to trend higher in the near term. The opposite holds true when the ratio is below 1.0.)
DEMAND DRIVERS. The sector's long-term fundamentals remain strong. Rapid growth in semiconductor-rich applications, such as cellular phones, data networking, automobiles, and consumer electronics, signals continued robust demand for chipmaking equipment. Tortoriello expects chip sales to top $250 billion by 2005, up from $204 billion in 2000.
That's good news for the gear makers. To support this growth, chipmakers will need to replace existing equipment with manufacturing tools that can support new technological requirements. Three important demand drivers include the ongoing shift to 300-millimeter wafer processing, the introduction of copper interconnect materials, and the continued shrinking of circuit lines from 0.18 micron to 0.13 micron and below.
Although share prices have moderated in recent weeks, Tortoriello would buy only selected issues at present. He recommends that investors focus on well-established and well-financed companies with strong management track records, giving special attention to those with tools likely to garner leading market share in copper interconnect processes and 300-millimeter wafer fabs. Among his current favorites: FEI Co. (FEIC) and Kulicke & Soffa (KLIC), both of which carry S&P investment rankings of 5 STARS (buy).
S&P Relative Strength Rankings
These industries carry six-month relative strength rankings of "5" as of Mar. 8, 2002 -- meaning that they're in the top 10% of the 115 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior six-month price performance.
Largest Company (Market Cap.)
S&P STARS* Rank
Air Freight & Couriers/Industrials
Catalog Retail/Consumer Discretionary
Lands' End (LE)
Lyondell Chemical (LYO)
Computer & Electronics Retail/Consumer Discretionary
Best Buy (BBY)
Consumer Electronics/Consumer Discretionary
Harman International (HAR)
General Merchandise Stores/Consumer Discretionary
Home Furnishings/Consumer Discretionary
Leggett & Platt (LEG)
KB Homes (KBH)
Internet Software & Services/Information Tech.
Semiconductor Equipment/Information Technology
FEI Co. (FEIC)
Specialty Stores/Consumer Discretionary
Barnes & Noble (BKS)
*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS
(accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief sector strategist for Standard & Poor's