Looking Beyond the Quarter at Applied Materials

A Salomon Smith Barney downgrade reflects longer-term concerns, not second-quarter expectations.
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SAN FRANCISCO -- Wall Street expects Applied Materials (AMAT) - Get Report to report strong second-quarter earnings after the close today. But one analyst thinks that to focus on those numbers is to miss the bigger story.

Milind Bedekar, a semiconductor-equipment analyst for

Salomon Smith Barney

, Monday downgraded the stock to outperform from buy, citing a glut of dynamic random access memory chips on the market. The downgrade puzzles his peers because the analyst maintains a bullish forecast: The

First Call

consensus of 25 analysts has Applied earning 27 cents a share, down from 37 cents a year earlier, while Bedekar expects a 32-cent profit. (Salomon Smith Barney has not performed underwriting for Applied Materials.)

Bedekar's concerns are clear enough: The chip-equipment industry depends in part on orders from memory-chip makers, which are seeing a glut in DRAM chips. A drop-off in orders would be akin to a cylinder going out in a four-cylinder engine -- without it, the car simply won't go as fast.

But what about the bullish second-quarter estimate? "When a guy downgrades a bunch of stocks but doesn't change his estimates or price targets, he's confused," says

NationsBanc Montgomery Securities

equipment analyst Brett Hodess, who is forecasting quarterly earnings of 30 cents. (NationsBanc has not underwritten for Applied.)

Not so, says Bedekar. "This stock doesn't

move on this quarter's numbers," he argues. Instead, you have to look months out. In 1996, for example, the stock peaked in August even though equipment orders didn't start to decline until February. "Without a doubt, this is an absolutely terrific quarter," he says. "But we are taking the foot off the gas."

Bedekar is basing his assumptions on oversupply in the DRAM market, which should bring pricing down and keep memory makers from investing heavily in new equipment. While demand for equipment seems to be increasing from non-DRAM chipmakers, that's a much smaller portion of the customer base, he says.

Hodess disagrees. "I think it looks pretty good," he says. "The DRAM companies are saying they won't change their spending patterns." Applied's forecast has been for strong business trends and sequential growth for several quarters out, he says.

Hodess isn't the only analyst differing with Bedekar's assessment.

First Security Van Kasper's

Gerry Fleming expects the company to earn 28 cents for this quarter and says that the future looks good. "We are telling people, 'You want to own the stock,'" he says. Last week, three of the biggest chip manufacturers mentioned increasing capacity, he notes, which translates to increased spending for equipment. (First Security Van Kasper has not underwritten for Applied.)


Goldman Sachs

, equipment analyst Gunnar Miller says the company appears to have its third-quarter orders filled and is already at work on its fourth-quarter orders. "We would be surprised if forward guidance didn't continue up and to the right," Miller wrote in a report Monday. (Goldman Sachs hasn't performed underwriting services for Applied.)

There is little disagreement on the second-quarter numbers and that Applied will report orders for new equipment (the equivalent of a blood-pressure reading for an equipment maker) of around $1.4 billion. That level's significantly above the company's previous guidance of $1 billion and the $1.03 billion it reported for the first quarter ended Jan. 31.

The analysts do differ on how investors will react. Bedekar says the stock is at a peak and will come down on concerns about a year-end slowdown. But Mark Fitzgerald, an equipment analyst for

Merrill Lynch

, like others surprised by Bedekar's thoughts, expects investors will buy the stock. He's anticipating the company will report orders as high as $1.5 billion, which would represent sequential growth of more than 40%. (Merrill Lynch has not underwritten for Applied.)

As far as Bedekar is concerned, just wait. "Even the July quarter will be fine," he says. "But the stock is peaking."

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