SAN FRANCISCO -- These days everyone's feeling good about semiconductor equipment makers like Applied Materials (AMAT) - Get Report and KLA-Tencor (KLAC) - Get Report. After all, Applied Materials is now trading at a generous 71 times earnings and KLA is at 38 times earnings.
But back on July 21, it was another story. The industry had been in a slump for a year. Applied Materials' P/E was 19 and the stock was trading at 30, 40% below its August 1997 high of 50. KLA sported a P/E of 18 and was trading at 27 -- a whopping 63% below its August '97 high of 74. No one saw any sign that the industry would recovery any time soon. No one, that is, except
NationsBanc Montgomery Securities
BancAmerica Montgomery Securities
) analyst Brett Hodess.
He had the gumption to hold a conference call with some 170 fund managers and tell them the bottom was nearing and it was time to buy equipment leaders like Applied Materials, KLA and
. His firm is not an underwriter for any of the stocks.
Other analysts sneered. "The outlook for the next six months is very bad for capital equipment sales,"
analyst Mark Fitzgerald said. He predicted new lows for the group and maintained a neutral rating on Applied Materials.
Hodess says he too was nervous about new lows. But there were three things he noticed. First, the equipment sector was showing price-to-book and price-to-sales valuations near historical lows, but the companies were better capitalized and therefore fundamentally stronger than in the slump of 1996. Secondly, semiconductor giants
were announcing 0.21- and 0.18-micron products. "But none of these guys had 0.21- or 0.18-micron equipment," Hodess says. For the companies to come out with the products on schedule, they would need to order new equipment soon. Finally, he knew that once equipment stocks start moving, they move up fast, leaving behind investors who wait too long.
Yang Lee, a manager for the $2 billion
Third Avenue Funds
, was buying low-priced equipment stocks before Hodess made his July call but didn't expect the stocks to pick up as soon as they did. "Everybody was saying not yet," Lee says. "Hodess was the first pounding the table."
But for the most part, the Street didn't listen. Although Applied Materials rose 9% in the two weeks after his call, it then sunk 36% to close at 22 3/8 on Oct. 8. Yow!
"I was getting a lot of flack through August and September," Hodess recalls. "A lot of people were questioning how I could be so certain that orders would bottom by year-end." At the Montgomery Securities investment conference in mid-September, Hodess was clearly nervous and said a new low could be reached in December -- which happened. Applied Materials, for example, dropped by 13% from Dec. 8 to Dec. 14. ("Typically late in the fourth quarter everyone starts questioning whether PC sales are really good or not," Hodess says.)
In a Sept. 25 report he tried to cover his tail. "With the potential for orders to continue to show small declines through the end of the year," he wrote, "the stocks are unlikely to sustain a recovery in the next several months." But he didn't change his ratings, and he continued to tell investors to buy the equipment leaders.
On Oct. 8 the
Philadelphia Semiconductor Index
hit a two-year low and Hodess got back on the phone and rustled up those 170 odd fund managers. This time he said his previous call was early but now the bottom had been reached and the stocks would go no lower. Buy, buy, buy, he said.
And the stocks took off. In the three months after he reiterated his buy call, Applied Materials rose 103%. Not everyone saw this even in October. In an Oct. 9 report,
BancBoston Robertson Stephens
analyst Sue Billat had issued a buy rating on only one of her equipment stocks --
. The rest, including Applied Materials, she rated long-term attractive. Robbie Stephens is a managing underwriter for Applied Materials.
Needham & Co.
analyst Theodore O'Neill downgraded Applied Materials from buy to hold on Oct. 8 and reiterated it on Nov. 3.
Source: Nationsbanc Montgomery Securities.
To say that Hodess has semiconductors in his blood makes him sound like a Star Trek character -- but he did spend three years working for his father's company,
, which builds semiconductor clean rooms. Before that, he spent five years as an Intel research engineer after getting a B.A. in physics from Bowdoin College in Maine and a B.S. in engineering from Columbia University. Hodess later went on to get an MBA at the University of California at Berkeley. He has spent the past seven years at Montgomery. Since then he has been named to the
All-American Research Team three times.
What next? Hodess is already looking for the next downturn. The time to sell, he says, will be when lead times in orders from semiconductor makers start to shorten and plant utilization rates start to drop. Most analysts, he predicts, will rationalize the first declines as a healthy cooling of an overheated market. "That's usually crap," he says. "It's usually the beginning of overcapacity."
That's calling 'em like he sees 'em, Hodess style.
For more info on institutional holders of these stocks, as well as financial statements and earnings estimates, please see the Thomson Company Reports.