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Deutsche Bank’s Steve O’Rourke cut his ratings yesterday on KLA-Tencor (NASDAQ:KLAC), Lam Research (NASDAQ:LRCX) and Novellus (NASDAQ:NVLS), citing concerns about the near-term prospects for the semiconductor equipment sector.

“We believe that real and potential memory sector fundamental weakness (i.e., overcapacity), the anticipated absence of increased spending levels from major foundries, and on-going strategic spending by memory manufacturers will precipitate a capacity digestion period that is likely to ensue in [the first half] as measured by equipment order rates,” O’Rourke wrote in a note. “We anticipate a downward revision of consensus estimates for SCE [semiconductor capital equipment] companies, and despite comparatively strong mid-cycle earnings power we anticipated near-term re-tracement of recent [semiconductor capital equipment] stock gains.”

For 2007, O’Rourke says his bottoms-up analysis indicated overall semiconductor capital spending up about 2% from 2006, but says a decline “is more probable.” He notes that the industry utilization rate fell to 89.1% in the third quarter from 91.8% in the second quarter; he thinks the number will drop to the mid-80's early this year, with the foundries “likely below that.”

O’Rourke dropped Lam Research and KLA-Tencor to Hold ratings from Buy; he went to Sell form Hold on Novellus.

Also yesterday, Credit Suisse’s Satya Kumar raised his price target on KLA-Tencor to $50 from $45, asserting that the stock could trade higher heading into its coming earnings announcement, as the company files delayed 10-K and 10-Q filings, among other factors. Kumar says the consensus estimate for the December quarter and for calendar 2007 “have upside.” He also says a buyback of about $1 billion should be coming at some point in the first half. Nonetheless, he retains a Neutral rating on the stock.

Source: Deutsche Bank on KLAC, LRCX, NVLS: Proceed with Caution