Sunday, March 10, 2013

Applied Materials Signals a Stronger Semiconductor Market

Last year was a pretty tough one for the semiconductor industry. The year started off with the industry expecting a second half ramp that didn’t occur. In fact things got worse. All of which leads into a 2013 which sees, you guessed it, a second half ramp predicted.

Frankly I think it is too simplistic to think about the industry in general terms. This may have been the case in previous cycles, but there are some significant changes in end demand within consumer electronics, and much of this was expressed in Applied Materials' (NASDAQ: AMAT) recent results.

Applied Materials Semiconductor Commentary

I like looking at stocks like AMAT because the capital equipment plays usually give an early read on where the industry is headed. There are very few better early cycle economic indicators than the semiconductor industry. In general, things have been looking up. The Semiconductor Industry Association (SIA) has been making more positive noises on the industry recently. The SIA is reporting ongoing strength in the Americas and better conditions in Asia Pacific (ex Japan), while conditions in Japan and Europe remain weak. Within this there are winners and losers.

Essentially there is change in demand within computing and mobile devices. The winners are smartphones, tablets and iPad devices, while the losers are PCs and laptops. These changes are arguably more important to understanding the direction of the industry. It’s not enough anymore to just look at PC sales and hope for a refresh cycle to come along or a new Windows version to spur sales.

A brief summary of the key takeaways from Applied Materials' recent results:

  • Semiconductor orders up 80% in Q1, indicating the kind of growth that characterizes the passing of a trough in the cycle.
  • The outlook for NAND has gotten stronger with demand from smartphones forecast to be up 35% and 55% from tablets.
  • The logic market is predicted to be flat for AMAT this year as the PC market weakens but is counterbalanced by growth in touch enabled hybrid models and Ultrabooks.
  • DRAM prices are rising, but expectations are for investment to be weak as the PC market continues its decline.
  • The Solar market remains weak with industry consolidation taking place at a slower pace than expected. The industry remains plagued with overcapacity so even as end markets pick up, the supply chain remains weak.
  • Net Sales are forecast to be down 5-10% from as opposed to a 5-15% forecast decline at the time of the last set of results.

From Applied Materials perspective it has been restructuring in order to react to changes in underlying demand. Solar investments have been written off, and the cost base of the company has been reduced. As such, analysts have AMAT on for a 10% revenue decline this year with EPS down 19%, but things are forecast to turn around sharply in 2014. In fact EPS is estimated to be up 73% to $1.06, leaving the stock on a PE of potentially just 13x in October 2014. Furthermore, I note that EPS estimates have been notably hiked in the last month or so.

There is no doubt that the investment community is pricing in a cyclical upturn in the semiconductor cycle.  With that in mind it's worth thinking about some of the ‘hidden’ or tangential plays.

Stocks Exposed to the Semiconductor Cycle

Before delving into the less obvious plays, it's worth looking at Intel (NASDAQ: INTC). The key issues with the stock were discussed in an article linked here. Gross margins are forecast to improve, and inventories have been reduced; these are classic signs of a trough being passed. On the other hand the company faces some of the challenges outlined above. It needs to reduce its exposure to the PC market, and its hope is that the computing market will shift towards the kind of PC/tablet convertibles that it believes are the future. Again it is too easy just to classify it as a pure play on a recovering semiconductor market. The details matter.

Two companies that I like from a more esoteric perspective are Cognex (NASDAQ: CGNX) and Dover Corp (NYSE: DOV). Cognex is better known as a play on increased automation, but within this it has significant exposure to consumer electronics and semiconductor end markets. If they are coming back this year than we can expect some marginal contributions from these end markets. To put some perspective here, its semiconductor and electronics capital equipment sales declined 24% last year and only contributed 9% in 2012. However, much of its semiconductor based sales are to Japan, so investors need to look out for better news there from the SIA.

With Dover Corp it might seem odd to talk about a well known industrial as a semiconductor play, but if we look at the company in depth we can see that its Sound Solutions business is heavily exposed to expanding smartphone sales. The newer phones tend to have 2-3 times more microphones in them, and if AMAT’s predictions of strong emerging market smartphone sales come true then Dover will be a winner. Moreover, the only major handset manufacturer that Dover doesn’t have a strong working relationship with is Apple, so it has diversified exposure to the main players in the marketplace. Rather like Cognex, it is a story of its weakest division bouncing back.

The Bottom Line

Increasingly it appears that conditions are getting better with the semiconductor industry, and I think it’s time to start filtering these views into stocks within your portfolio. If you don’t want pure play exposure with something like AMAT and are concerned about Intel’s positioning then Cognex and Dover Coro are well worth a look.

No comments:

Post a Comment