LED Stock Outlook 2011: Digging a Hole to China?

NEW YORK ( TheStreet) -- It's been a difficult week for Veeco ( VECO) and Aixtron ( AIXG), the makers of core equipment in the LED market.

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Veeco shares are down 15% through midday Friday, and Aixtron shares are down by roughly half that amount. All it took was a downgrade from Citigroup -- based on fears that the Chinese subsidy support for the equipment makers' sales will be cut off -- to send the stocks down early in the week.

The LED equipment stocks tanked again on Thursday afternoon, though, after a Chinese newspaper quoted an official from Yangzhou as saying that the subsidies will be cut as of July 1, 2011. The Chinese press report also quoted the Citigroup analyst.

Between Citi and the Chinese region where the LED subsidies first began, the LED equipment makers can't catch a break. On Friday, Aixtron shares continued sliding, while Veeco share bleeding stopped after its 15% loss for the week.

That said, several LED stock specialists say that all the focus on the China subsidy issue, particularly as it only focuses on one city in China, is missing the forest for the trees when it comes to analyzing what will make or break LED stocks in 2011.

For one, Mark Miller, LED analyst at Noble Financial, noted that several Chinese provinces had previously indicated plans to cut the LED subsidies for equipment purchase in the third quarter 2011. The quote from the Yangzhou official in the Chinese press, therefore, was stating a fact already expected.

Andy Abrams, LED stock analyst at Avian Securities, said that investors need to keep in mind that the subsidy chatter isn't from the central government in China. Subsidy policy is at the local level for LED equipment, and the cities are in competition with each other. Therefore, just because one Chinese city indicates it's planning to cut subsidies, it doesn't follow that all the subsidies will be eliminated.

The Citi analyst said in his downgrade of Veeco earlier this week that Yangzhou had already stopped providing subsidies. However, according to a translation of the article in the Chinese press quoting the Yangzhou official and provided to Avian Securities, the Chinese official actually indicated subsidies would end in July.

Of course, as it's been widely noted, the LED sector is one that moves on greed and fear and since these stocks had run up so considerably in the past month, valuation is always under the gun and investors quick to pull the trigger.

There is little doubt that froth exists in the Chinese LED market based on the subsidies. The government official quoted in the Chinese press report indicated that businesses were putting in applications for the subsidy that didn't even know the first thing about LED production.

Yet on the other hand, a mid-year cut in Chinese subsidies could increase deliveries in the short-term, with Veeco and Aixtron getting orders out as fast as they can. Additionally, Avian Securities' Abrams says that the real players in the Chinese LED market are not going to be canceling orders if the subsidies expire; they will just find financing elsewhere.

"The real issue is not whether there is help from the Chinese government in the form of subsidies, but how much real demand there is and how much capacity is being built in China, and how fast that capacity is coming online," Abrams said.

Noble Financial is banging the table of a macro view of the LED market, as opposed to a short-friendly view based on subsidy headlines. Noble estimates China will have 370 LED manufacturing machines installed by early 2011. To obtain its goal of a 33% share of LED production by early 2012, China will need to purchase an additional 570 machines.

"Even if China does pull back, in order to have capacity to produce 125 billion LEDs by mid-2012, another 1,450 tools will have to be added to the worldwide installed base."

The Noble Financial analyst says that, as usual, rumors of the death of the LED market are greatly exaggerated. "While it is likely that MOCVD tool orders could trend down for a couple of quarters next year, we believe that investor concerns about a prolonged and major decline in the MOCVD tool market are overblown," Miller wrote in an email to TheStreet.

The Avian analyst thinks that this week's focus on Chinese subsidies misses the mark, too, but from a different perspective. Abrams, whose downgrade of the LED equipment players back in August helped to spur the last sector selloff, says the recovery in the LED backlighting business for the flat panel market is still the more important mover for the 2011 outlook. Abrams downgrade of Veeco and Aixtron last August was based on the glut in the backlighting market.

If the backlighting business doesn't pick up, and China slows in ordering, there could be a demand hole in the middle of the year. Yet whether the LED backlighting market gets better quickly or not is the swing factor, whereas the China subsidy issue is a short-term impact that doesn't make or break stocks for the year, the Avian analyst contends.

For the moment, though, it's impossible the get a read on the overall market conditions, and that's why something that some analysts contend is an overblown issue can move the LED stocks into freefall mode. "We're in a dead zone now," the Avian analyst said.

-- Written by Eric Rosenbaum from New York.

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