Report Card: Jay Deahna

Jay Deahna Morgan Stanley Dean Witter
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2nd Place Semiconductor Equipment

Bio

B.S., Northeastern University; M.B.A., Boston University. Deahna has tracked the semiconductor capital equipment industry at Morgan Stanley Dean Witter since 1996. Before that, he worked in a similar capacity at Prudential Securities.

Industry Outlook and Style

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Before assessing individual companies in the semiconductor equipment sector, Deahna's first priority is "getting the cycle right," as he puts it. Currently, the chip cycle is experiencing a downturn.

Deahna expects, however, that the present deceleration in semiconductor revenues will bottom out in the third quarter, at which point there should begin a new, multiyear reacceleration phase. "We know that equipment stocks trade tightly off the change in the semiconductor industry's growth rates," reasons Deahna. "Accordingly, in the first two quarters, equipment stocks will be flat to down. But as we move into the latter part of the second quarter, the stocks will likely start to anticipate the reacceleration we forecast will start in the fourth quarter."

"Getting the companies right" is Deahna's second priority. In his view, the equipment industry is gradually splitting into two groups, "those companies that have pricing power and those that don't."

The ones with pricing power are those that are keeping up with trends in the industry -- namely, a move toward smaller process technologies and larger wafers. "The premise of my picks," explains the analyst, "is that their equipment solves the toughest challenges in the move to advanced technologies and larger wafers. As a result, these companies have significantly better pricing power than the average industry price progression."

The companies Deahna likes best specialize in one of three processes: inspection and metrology, photomasks or photolithography.

The names he recommends among the inspection equipment makers are KLA-Tencor(KLAC Quote), Nanometrics (NANO Quote) and Rudolph (RTEC Quote).

Among the photomask producers (photomasks are the filters that transfer patterns onto a chip), he prefers DuPont Photomasks (DPMI Quote). And among photolithography providers, he favors ASM Lithography(ASML Quote) and Cymer (CYMI Quote). (Morgan Stanley has investment banking relationships with ASML, Cymer and DuPont Photomasks.)

Deahna has strong buys on Cymer and DuPont and outperform ratings on ASM Lithography and KLA-Tencor. (He does not officially cover Nanometrics or Rudolph.)

Still, investors should not forget the importance of the cycle. The cycle's downswing means that the short-term outlook is unfavorable for the chip and chip-equipment industries as a whole. Capital and consumer spending -- the drivers of demand -- have plummeted.

The Federal Reserve's January interest rate cuts should help encourage more capital spending, but the effects won't likely be felt for another six months. In the meantime, spending is sharply down from 2000, when outlays increased 75%. The Morgan Stanley analyst projects that in 2001 capital spending will fall 15%-20%.

For these reasons, Deahna has recently cut estimates on the companies' earnings for 2001. He also warns that the stocks may retest previous lows -- and test investors' patience -- before they perk up as the cycle turns favorable.

And even with his recent estimate cuts, Deahna concedes, "It's safe to say that for the next four to five months, analysts will likely further lower numbers across the board. Most growth-oriented investors won't get involved until the cuts have been concluded and visibility for a return to sequential growth emerges."

Stock Pick

Favorite stock for next 12 months: DuPont Photomasks
12-month target price: $90
Comment:
"DuPont Photomasks is in the midst of experiencing the biggest fundamental shift in the entire semiconductor food chain. At 0.18 microns and below, which started recently in volume production, photomasks become an enabling technology. In previous generations (0.25 microns and above), photomasks were largely a commodity. The 0.18-micron node is the first generation where chipmakers are projecting images onto the surface of a silicon wafer that are smaller than the wavelength of light in a photolithography imaging system.

"Photomasks plug into photolithography systems like a negative into a photography enlarger and actually facilitate the 0.18-micron-and-below imaging process. Here are two indicators of DuPont's enhanced position in the industry: 1) Last spring the company raised prices across the board for the first time in the history of the mask industry. 2) In the fourth quarter of 2000, DuPont accepted prepayments for the first time in its history to guarantee 0.15-micron-and-below mask-making capacity to some of its customers."


Rate Their Stock Picks:

Which stock do you like best? Miller: Lam Research Deahna: DuPont Photomasks Rogers/Pitzer: KLA-Tencor