Analysts Call for Tempered Views on Chip Equipment

Both Banc of America Securities and Adams Harkness & Hill have adopted somewhat negative views on the semiconductor-equipment sector, and the research firms downgraded the biggest names in the group Tuesday, saying investor expectations have gotten too high.

In a research note, Banc of America said it isn't optimistic "that the earnings power of the semi-equipment group into 2004 can sustain the current rally." The firm also said that slower growth, added competition and a lack of new applications suggest that industry profits will fall short of the 1990s cycles.

The firm cut its rating on Applied Materials ( AMAT), KLA-Tencor ( KLAC), Novellus ( NVLS) and Lam Research ( LRCX) to neutral from buy, and lowered its rating on Credence Systems ( CMOS) to sell from neutral.

"The rally in the semi-equipment space over the last several months is probably anticipating an industry recovery fueled by a turn in the economy," Banc of America said. "We do agree there is a recovery ahead. But we don't believe an inflection in fundamentals is enough to take the stocks further. The rally will increasingly need to be justified by earnings, and herein lies the problem."

Banc of America added that "if our industry view is correct, we'd expect the group to underperform in 2004 as the earnings story lags prior cycles and falls short of current projections."

The firm advised long-term investors to stick with large-cap names or the small-caps with strong intellectual property, while avoiding those companies that tend to burn through a lot of cash.

Similarly, Adams Harkness said the recent action in the chip-equipment sector suggests investors are too geared up for a turnaround.

"The semiconductor-equipment stocks have moved significantly lately, pricing in high expectations for an upturn, which we estimate to haveonly a 50% probability of occurring," Adams wrote in a research note. "We believe the reward/risk ratios for most of our stocks looks unappealing based on their current price levels and the significant risk remaining."

While the semiconductor business is no doubt improving, the firm said, "inventories are building and demand remains tenuous," meaning a second-half disappointment is possible. "Even if we get the long-awaited second-half recovery in 2003, we think the stocks will struggle to move significantly higher from their current levels, as stock prices shift to earnings-driven valuations on 2004 and 2005 earnings," the firm said.

Adams said its remaining buy-rated stocks are ADE Corp. ( ADEX), Cognex ( CGNX), Cymer ( CYMI), Mykrolis ( MYK) and August Technology ( AUGT), which was reduced from strong buy.

The firm cut its rating on a number of stocks to market perform from buy, including Applied Materials, Novellus, Advanced Energy ( AEIS), Asyst Technologies ( ASYT), Brooks Automation ( BRKS), MKS Instruments ( MKSI) and Varian Semiconductor ( VSEA).

Adams dropped KLA-Tencor, ATMI ( ATMI), Kulicke & Soffa ( KLIC), Newport ( NEWP) and Veeco Instruments ( VECO) to reduce from market perform ratings.

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