Chip, Gear Makers May Be Grinding Gears - TheStreet

Updated from May 30

Despite investors' wishes to the contrary, IT spending remains weak -- and it's looking more like it will stay that way through the second half of the year.

That's largely why a slew of semiconductor-equipment stocks have taken it on the chin since last Friday, when Goldman Sachs broached the possibility of an

easing in demand later this year.

Since then, the Philadelphia Stock Exchange Semiconductor Index has lost 6.9%, while bellwether

Applied Materials

(AMAT) - Get Report

has given up 11.6%, closing Thursday at $22.59.

Meanwhile, competitor

Novellus Systems

(NVLS)

got dinged two days in a row since it failed to allay investor fears of a second-half stall during its midquarter update Tuesday. It's fallen 7% since Tuesday.

That's a sharp turnaround from earlier bullishness on the sector. From February through last week, when Goldman downgraded a raft of industry leaders, the average chip-equipment stock outperformed the Nasdaq by nearly 30% amid evidence of rising orders.

But in retrospect, it appears demand in the first half of the year was helped along in part by inventory restocking. "We've had a tech-stimulated upturn. That's stimulated some growth, but there's also been an inventory readjustment. We were overdepleted in inventories at the end of the year, and we've had a rebalancing, so now that's basically over with," says Deutsche Bank analyst Timothy Arcuri. "The obvious question is, what's next? On that front, it still looks somewhat dicey."

Thursday night's report on worldwide chip sales by the Semiconductor Industry Association noted sequential growth in April, but wasn't inconsistent with arguments that the recent spike was inventory-related. Global sales rose 3.1% in April vs. March to $110.07 billion. But year-over-year, sales were down significantly in most regions, with Japan taking the lead, down 34.5% vs. April of last year. Global sales were down 19.4% vs. last year.

IT Swirl

A report out from Merrill Lynch on Thursday lent more weight to the notion that tech spending isn't going to rebound anytime soon. A survey of chief information officers in the U.S. and Europe suggests the average IT budget actually will shrink by 0.5% this year.

Traditionally, PC purchases have driven demand for chips, which has in turn fueled orders for chip equipment. But only 8% of the survey respondents said they expected to upgrade their companies' PCs later this year. A plurality of 44% said they'll hold off on upgrading their PCs until 2003.

"We're a little concerned because orders are not coming in as fast as we would normally expect for the purposes of ramping up in the third and fourth quarter," says Mary Olsson, lead semiconductor analyst for research firm Gartner. June through August tend to be active months in the industry, as companies stock their shelves for back-to-school purchases. But lately she's seen evidence that businesses are pushing out orders until later in the year, or simply putting in smaller orders than usual.

In the Merrill survey, the vast majority of respondents, 80%, said they don't expect to boost spending much in the fourth quarter, which is typically when companies do the bulk of their spending.

Scenarios

For now, Gartner is projecting a 3% worldwide gain in chip revenue for the year, assuming some pickup in IT spending.

But it also offers a worst-case scenario: If businesses decide not to reinvest in capital equipment in the second half of the year, chip revenue actually could drop 5% worldwide for the year.

Causing further consternation in the semi industry, prices for memory chips have tanked following a failed

takeover bid by

Micron

(MU) - Get Report

, which would have sopped up excess supply from the market.

According to a report, Goldman Sachs' Asia office predicted Thursday that if inventories at memory-chip leader

Samsung

keep building, the company may have to release excess inventory on the market. That could force DRAM spot prices down to as low as $1.50 (for a 128 Mb SDRAM component), which would be sure to slam chip-equipment makers.

"If chipmakers can profitably make these memory chips, they will have an incentive to invest in their future" by buying more equipment, says Jeremy Lopez, an analyst at Morningstar. But if prices continue to slump, expect increasing pressure on stock prices across the sector.