Expected Drop In Memory Cap Ex Threatens Semi Equipment Companies

Semiconductor equipment stocks may have enjoyed too much of a good thing. Satya Kumar, an analyst with Credit Suisse, cautions today that there is a “plausible scenario” in which memory sector capital expenditure could decline over 50% from recent quarterly levels “to reestablish an equilibrium [of] cash inflows and outflows for memory companies.”

Kumar says some investors wonder how memory companies have managed to spend over 40% of their revenue on cap ex over the 2005-2007 period. He notes that memory companies don’t generate much free-cash flow. As a measure of sustainable capital spending levels, he suggests using a ratio of EBITDA/cap ex.

The figure averages 112% from the first quarter of 2002 to the fourth quarter of 2006, he notes, a period in which memory cap ex grew to $25.3 billion from $6.5 billion. Lately, he says, EBITDA/capex is running at 27% - in other words, the companies are spending dramatically more on capital goods than they are generating in cash. “EBITDA is so much lower than cap ex that companies have to fund 75% of their cap ex” to sustain Q2 levels, or about 60% of Q2 revenues.

He sees the biggest risk of cap ex cuts at Hynix and Taiwan DRAM companies. He notes that Lam Research (LRCX) and Varian Semiconductor (VSEA) have the most exposure to those companies; he also sees risks for Cymi (CYMI) due to recent Intel (INTC) and Samsung push-outs.

Writes Kumar: “Ultimately, the laws of economics will prevail; unfortunately, when that happens, SCE [semiconductor capital equipment] companies may be the last ones to let us know.”