Stocks in the notoriously cyclical semiconductor equipment sector have fallen sharply from their recent highs, but for the patient investor, suggests Andy Ng in Morningstar, there are some bargains to be had. In particular, Ng recommends Applied Materials (AMAT), KLA-Tencor (KLAC), Novellus (NVLS), and Cymer (CYMI).
* Applied Materials is an immense player in a field of smaller rivals. Ng argues that Applied's $1 billion annual R&D budget will keep it at the industry's forefront, and that the company has also been expanding into the potentially lucrative field of solar manufacturing equipment.
* KLA-Tencor has captured more than half the market in PDC (process, diagnostic and control) tools, a crucial sector of the industry. Ng points out:
The firm's moat stems from KLA's leading technology expertise and extensive knowledge base, which are supported by the largest R&D budget in the PDC market (more than $400 million in fiscal 2007)... KLA has bright long-term growth prospects ahead as the firm reaps benefits from advances in semiconductor fabrication technologies. We believe that technology-driven PDC tool purchases by chipmakers, who are transitioning to the next generation of circuit sizes (45 nanometers), should help KLA somewhat offset the effects of the semiconductor equipment industry downturn.
* Novellus, a leading supplier of deposition equipment, has notched up successes despite facing tough competition from Applied Materials. Part of this, Ng reports, could be attributed to its R&D budget of more than $200 million annually.
* Cymer dominates the supply of light sources used during the photolithography process. Ng believes:
... that Cymer's moat stems from its cutting-edge technology expertise in a highly arcane field, and the large sums the firm spends on R&D in this niche area dwarf those of its upstart rival Gigaphoton. Although Cymer steadily lost market share to Gigaphoton throughout 2007, we view this as a temporary trend. We expect the firm's technology leadership to come into play in the future, as the transition to 45-nanometer (circuit size) volume production by chip manufacturers will require the most cutting-edge lithography light sources and will provide an opportunity for Cymer to recapture market share from Gigaphoton.