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Get Four
|  | MARCH 14, 2005
 TECH KNOWLEDGE By Colin McArdle A Chipmaking-Gear Standout While it may be too early to call the turn among semiconductor-equipment makers, Boston-based Brooks catches S&P's eye We at Standard & Poor's see semiconductor equipment demand remaining weak during the first half of 2005, as indicated by comments from leading chip manufacturers and by recent order deferrals due to tighter capital spending budgets. But the inventory buildup during 2004 should ease during the first half of this year. We see overall sales growth of 5% for semiconductor equipment, with slightly higher growth rates for technology leaders in the front end of the manufacturing process because we believe customers need to invest more to transition to smaller nodes in the future. PC unit shipments remain soft, and we believe there's some reluctance on the part of companies and consumers to commit to information-technology spending. In the most recent round of earnings for semiconductor-equipment companies, including industry bellwether Applied Materials (AMAT ; S&P investment ranking 4 STARS, buy; recent price, $16.66), the majority of companies reported slightly better earnings per share than our expectations -- and our estimates tended to be higher than the Street's. However, for companies that report on a calendar-year basis, fourth-quarter orders declined by approximately 20% on average. NEARING THE BOTTOM? Orders for Applied Materials' first quarter fiscal 2005, which ended in January, fell by 36% sequentially, suggesting that business essentially dried up in the December-January period. While some of this slowdown can be explained by seasonal factors, we think a challenging operating environment persists, at least in the near term. Guidance from most management teams for the current quarter remains weak, and we expect sequentially lower sales and earnings in the first quarter of calendar 2005. Chip-equipment managements continue to maintain that visibility is very low. Interestingly, several companies expressed the belief that the industry is either at, or near, the bottom. At S&P, we would agree with this assessment if we based our opinion on year-to-date stock performance as a forward-looking indicator. The S&P Semiconductor Equipment Index rose 1.2% year-to-date through Feb. 18, 2005, vs. a drop of 0.8% for the S&P 1500. While industry book-to-bill (sales divided by orders) ratios continued to gyrate around 1 (a number above 1 is a sign of growth), with a range of approximately 0.95 to 1.05 for the last six months or so, the January number of 0.80 represented a dramatic decline in business. Prior to this, the December 0.95 number also indicated ongoing weakness, but to a lesser extent. We would suggest that at least some of this month-to-month decline is seasonal. The February data, which should be released in the next few weeks, could show some preliminary evidence as to whether a recovery is likely in the near term. STAR QUALITY. Despite our neutral outlook on the group, we'd like to highlight a stock that we believe is a market leader in the segments in which it competes: Boston–based Brooks Automation (BRKS ; S&P investment ranking 4 STARS; $16.64). We think standing in the company's R&D facility must feel something like a visit to the set of a Tim Burton film. Robotic arms and other mechanized equipment appear to be slaving away in a sort of dance that Willy Wonka might have envisioned. Brooks has maintained a leadership role in high-tech factory-automation equipment for years. It's the leading supplier of semiconductor tool and factory equipment and software automation. It has a particular expertise in the areas of cluster-tool vacuum-processing environments and integrated factory-automation-software applications. Over the years, Brooks's product line has expanded considerably, from individual robots used to transfer semiconductor wafers to fully integrated tool and software solutions to control the flow of resources through a factory. In 2002, Brooks acquired PRI Automation in a stock deal valued at $536 million. The acquisition expanded Brooks's portfolio, adding products in factory transport and atmospheric tools, where its product offerings were weak or nonexistent. Factory transport, or automated material-handling systems (AMHS), are track systems used to automatically move wafers around a factory floor. COOL TOOLS. Revenues by operating segment in fiscal 2004 (ended September) were as follows: equipment automation 59%, factory-automation hardware 18%, factory-automation software 22%, and other 1%. The 20 largest customers accounted for 50% of fiscal 2004 revenues. In fiscal 2003, the top 10 customers accounted for 37% of total revenue. Tool-automation systems provide makers of semiconductor equipment with standard automation features to add to their tools. Major product lines include atmospheric and vacuum robots and modules, integrated vacuum and atmospheric automation systems, and liquid-crystal display (LCD) systems (for flat-panel display manufacturing). Factory hardware systems provide an interface between the factory floor and manufacturing equipment. Products include load ports, used to load wafer cassettes into a tool, and integrated front ends, which provide the interface between a tool and the factory floor. Factory hardware also includes 200-mm and 300-mm AMHS systems, added through the acquisition of PRI. Factory automation software ranges from manufacturing execution systems (MES), which manage the operations of an entire fab, and logistics software for scheduling and coordinating workflow, to individual software packages designed to meet specific requirements, such as preventive maintenance systems for equipment. GLOBAL REACH. Brooks serves a global marketplace, with 51% of revenue in fiscal 2004 coming from the U.S., 26% from Asia/Pacific, and 22% from Europe. It maintains a direct-sales and marketing organization across North America, Asia, and Europe. Backlog at the end of fiscal 2004 stood at $157.7 million, vs. $112.7 million at the end of fiscal 2003. We've applied a price-to-sales multiple of 2.0 times -– in line with Brooks's industry peers -- to our 2005 sales-per-share estimate to arrive at a 12-month target price of $22. While the shares currently trade at a relatively high p-e ratio of 22 times trailing 12-month earnings, we have a buy recommendation on the shares of this high- beta company. Risks to our recommendation and target price include pricing pressures and customer concentration. We also think Brooks could face increased competition from larger companies with greater economies of scale. In addition, deferrals of new fab production, due to higher interest rates and weak end demand for chips, would have a detrimental impact on demand for factory equipment. Brooks's high fixed-cost structure would also negatively affect gross margins, given any loss of volume. Note: Colin McArdle has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com Required Disclosures 5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis. 4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis. 3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis. 2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain. 1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis. As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations. All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041. Other Disclosures This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS. Disclaimers This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.  Analyst McArdle follows stocks of semiconductor equipment companies for Standard & Poor's Equity Research Services All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
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