Analyst Favorites in the Struggling Semiconductor Equipment Sector

by: The Wall Street Transcript

In a semiconductor equipment round table forum published August 28th, The Wall Street Transcript asked industry and equity analysts what their favorite stocks in the sector are. Their feedback is excerpted below:

Gus Richard, First Albany Capital

In the semi cap equipment, it would probably be Applied Materials (NASDAQ:AMAT). There are a couple of reasons. First of all, it is a dominant supplier. The valuation is attractive. It is going after the operating budget of its customers by building up its service offering. As any equipment business matures, you tend to focus on service as a way to drive incremental revenue. You sell the equipment and then you come in and you follow up with service to drive your growth. The company has a nice position in flat panel, which is growing. It has expanded that with the purchase of Applied Films. And then, interestingly enough, embedded in Applied Films was a wafer-based solar cell capability. In addition to that, Applied Films had a large area coating capability ' architectural glass. If you could take the large area, thin film coating capability and could do thin film solar over a larger area, then you could have a very large growth industry over the longer term. I don't think that that is priced in the stock. If there is a company on the planet that could pull it off, it is probably Applied Materials. It has more semiconductor manufacturing equipment experience than anybody else and it has aggregated all of the pieces to make that happen. We think it is an interesting company on valuation. You have a couple of drivers of upside in revenue as it turns service from a cost center to a profit center. It has a couple of adjacent markets that it is getting into. Over the nearer term, that is flat panels, and over the longer term, potentially thin film solar could really drive some growth.

Robert Maire, Needham & Company
I will separate it out into large cap and small cap. On the large cap side, we like Lam Research (NASDAQ:LRCX). It has been one of the better performing stocks. From an operational and financial point of view, at one point a number of years ago, that company was sort of on death's door and the current management came in and really turned it around. They have provided great leverage to the company. They have excellent execution; they have sort of stuck to their knitting and have been rewarded by the Street. As with other stocks, I think that we have seen a bit of a pullback here, but I think that over the long run, they have some pretty good earnings power. More important, on the down side, I think that they are less at risk than a lot of other companies. I think that they are sufficiently flexible in terms of their cost structure that they will maintain a higher level of profitability.

On the small cap side, a company that is similarly situated is Mattson Technology (NASDAQ:MTSN). They have gone through a similar sort of rebirth over the last two to three years. There was a lot of pain in the last down cycle, but some companies came out healthier for it. They have really turned their business around. They now are number one in their primary business and number two in their secondary business. They will likely remain more profitable and they seem to have some near-term order momentum that I find intriguing. Again, it's sort of a similar turnaround story with some earnings leverage and potential upside in my view.

Suresh Balaraman, ThinkEquity Partners

I like Rudolph Technologies (NASDAQ:RTEC). I truly believe that in five to 10 years from now, virtually all of the chips in the world will use copper wiring. And there is only one company that pretty much dominates all the measuring technology for that, which is Rudolph. KLA (NASDAQ:KLAC) recently announced that they are exiting that business. Right now, the stock is probably trading at 10-15 times current quarter's annualized numbers; they have $3 per share in cash. They have never lost money. And I just looked at their EBITDA and they are probably trading at 5 times EBITDA. So there is a lot of lack of expectations built into the stock. When you even out the fluctuations and the cyclicality, it's easy for the company to surprise investors.

I also like Varian Semiconductor (NASDAQ:VSEA). Again, this is one company that in my view has pretty much the only solution when they go from 90nm to anything below that. They are the only company that has a single-wafer system that actually works. Others are trying to get in, but these guys have 10 years of technology that they have already been through and they have made all the mistakes that they should make. Even in places where they never had any chance before, such as with the Japanese companies, they now love Varian's implanters. That's a company that is flush with cash. It doesn't have any debt. And I think that they are trying to completely outperform any kind of cyclicality. They may have some cyclicality, but they will be outperforming the industry for a very long time to come.

Steve O'Rourke, Deutsche Bank Securities
Mr. O'Rourke: In the larger cap names, I look at KLA and Lam. Lam is gaining share in a secular growth segment with very strong earnings power and a very solid operational management team. I don't think that's going to change. KLA dominates its respective space, has very strong earnings power, and a very solid market position. Both of these stocks have pulled back rather substantially from highs, and that's one of the other reasons why I like them now. Of course, this alludes back to my prior comment of these being more trading vehicles than they are long-term investment vehicles.

On the small cap side, I also have to say Rudolph, but I have to note that it's up quite a bit recently. To add to Suresh's comments about Rudolph, it's a company that has not gotten any credit for the acquisition of August Technology earlier this year; it was essentially a show-me story. I think that they have begun to deliver and you are starting to see some of that valuation discount maybe lift, and I do think that there is a fair amount more to go for a company like Rudolph.

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