Advanced Energy Industries Takes A Hit As The Semiconductor Cycle Is Still Sorting Itself Out

I believe Advanced Energy Industries (AEIS) highlights at least some of the risks I've seen in the rally in semiconductor and semiconductor equipment names. Even though the year-to-date performance is still strong (up about 18% as of this writing), the shares have come down about 15% off a recent peak on a combination of weaker first quarter results and guidance, as the market isn't seeing the quick, sharp recovery that investors want to believe is going to happen.

Another weak quarter (or two) remains in play as a risk factor, but I think these shares hold some appeal for more risk-tolerant investors. I don't see any real sign that AEIS is losing traction with its two largest customers (Applied Materials (AMAT) and Lam Research (LRCX)), and I think the long-term outlook and realities of the semiconductor market mean good long-term demand for chip-making equipment and AEIS's components.

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Advanced Energy Industries Takes A Hit As The Semiconductor Cycle Is Still Sorting Itself Out

As The Market Gets More Fearful About VAT Group, It's Tempting To Get Greedy

”Be fearful when others are greedy, and greedy when others are fearful.” - Warren Buffett

The Street’s unbridled love affair with semi-equipment stocks looks to be over, with investors increasingly worried about the prospect for equipment order push-outs and a general slowdown later in 2018 and into 2019, and perhaps an actual short-term contraction. That’s not great news for Switzerland’s VAT Group (OTCPK:VACNY) (VACN.S), as this leading provider of vacuum valves depends upon a strong semiconductor and display equipment order environment for its own growth.

I do believe there is sufficient evidence to support the idea that 2019 will be a much more challenging year, and there’s really not much visibility at this point. That’s a dangerous set-up, and buying equipment stocks going into a slowdown is often a painful (or at least frustrating) experience. But then, VAT is a significantly above-average equipment provider, and getting too cute about waiting for the ideal entry point could mean never owning the shares.

Investors should note that VAT Group’s ADRs are not very liquid; the local shares are considerably more liquid, but that may not be an option for all investors.

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As The Market Gets More Fearful About VAT Group, It's Tempting To Get Greedy

Advanced Energy Industries Closer To The Edge

Everybody has probably seen at least one video of a person (usually a male between the ages of 15 and 40) running full-speed at some sort of barrier that the runner assumes is lightweight and/or will be easily passed through… only to discover too late (typically upon regaining consciousness) that it was actually quite solid.

I mention that as an opening to the dilemma facing Advanced Energy Industries (AEIS) investors right now. Based upon what major customers like Applied Materials (AMAT) and Lam Research (LRCX) are saying, it looks pretty likely that semiconductor equipment demand growth will slow noticeably in 2019 - but is this a "lightweight" barrier that is just a dip in a long-term growth trajectory driven by new architectures and strong demand for IoT and memory or is the industry looking at a hard stop and a return to the "normal" cyclicality of past eras?

I'm cautiously optimistic that it is more the former than the latter, and it doesn't take hefty growth assumptions to drive a worthwhile fair value here. I advised caution on AEIS back in mid-February and the shares are down slightly since then (peers like MKS Instruments (MKSI) and Comet (OTC:CHLDF) (COTN.S) have done similar-to-worse, while XP Power (OTCPK:XPPLF) (XPP.L) has done better). I think this is still a risky call - buying tech into a slowing growth cycle is tough way to make money - but it's hard to ignore a well-run company with growing end-markets (on a long-term basis) and an interesting valuation.

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Advanced Energy Industries Closer To The Edge

Exciting Business Opportunities At Orbotech

I think there's a lot to like about Orbotech (NASDAQ:ORBK). The company is on the small side - or at least relative to giants like Applied Materials (NASDAQ:AMAT) and Lam Research (NASDAQ:LRCX) - but it doesn't play where it can't be a leader, and the company has three $300 million-plus markets to support growth in the coming years. Management has been pretty savvy at capital allocation and strategic decisions in the past, and I like Orbotech's chances to exploit demand tied to wearables, next-gen phones, IoT, and smarter cars.

Valuation is the fly in the ointment. The shares are near a 52-week high, as are many semiconductor tool companies, and today's price is about midway between my DCF-based fair value (which tends to run conservative for cyclical tech) and my margin-EV/rev-based fair value (which tends to run to the aggressive side). I think value investors would have to grit their teeth to love this one without making higher growth assumptions, but more momentum-oriented investors might find more to like.

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Exciting Business Opportunities At Orbotech

Seeking Alpha: Advanced Energy Industries Looking For A New Start

The angst over the health/trajectory of semiconductor capital equipment orders hasn't hurt Advanced Energy Industries (NASDAQ:AEIS) any more (or any less) than most of its peers. Applied Materials (NASDAQ:AMAT) has been noticeably weak since my February piece on AEIS, due to the fallout of its aborted merger with TEL, but AEIS, MKS Instruments (NASDAQ:MKSI), Entegris (NASDAQ:ENTG), Lam Research (NASDAQ:LRCX) and ASML (NASDAQ:ASML) have all clustered around low-to-mid single-digit loses over that span.

Given how tied Advanced Energy Industries is, and will be, to the semiconductor industry, that's not an unreasonable performance. The company has a good track record and reputation in supplying the semi equipment market with power conversion systems, remote plasma sources, thermal instrumentation, and so on, but the fact remains that major equipment buyers like TSMC (NYSE:TSM) and Intel (NASDAQ:INTC) have generally been buying less than expected and guiding down with respect to their plans as development timelines stretch out and the fabs reuse older equipment to save money.

Looking ahead, I believe AEIS is making the right decision in cutting its losses in the inverter business. Likewise, I think management is on the right track in looking to expand its precision power business beyond the semiconductor industry and into areas like medical devices and aerospace/defense. The "new" AEIS will likely emerge as a better, more profitable company, but the current valuation seems to largely reflect that.

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Advanced Energy Industries Looking For A New Start

Seeking Alpha: Mattson Looking For Advanced Chips To Drive The Cycle

Small-cap semiconductor equipment company Mattson Technology (MTSN), like most of its peers, has had its ups and downs recently as investors try to digest and interpret the guidance from major chip and foundry companies on their spending plans. Mattson still has the potential to leverage migration to 3D NAND and FinFET to significant revenue, profit, and cash flow growth, but it remains a risky call as it is a small player relative to Applied Materials (AMAT) and Lam Research (LRCX) and may find it difficult to maintain or grow its share during this next spending cycle.

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Mattson Looking For Advanced Chips To Drive The Cycle

Seeking Alpha: Mattson Technology: A High-Beta Play On 20nm And Below

Fellow Seeking Alpha contributor Ashraf Eassa and I have both written previously about Ultratech (UTEK), a semiconductor equipment company that we both like for its innovative positions in laser spike annealing (LSA) and advanced packaging lithography ("flip chips"), as well as the potential of its steppers in LED manufacturing. In particular, we have both made the case that advanced annealing technologies are likely to be a critical factor in the move to sub-20nm processes.

Ultratech isn't the only game in town, though, and there are multiple technologies and process steps that are going to play significant roles in the production of FinFETs and 3D circuits. With that, I would take a look at Mattson Technologies (MTSN), as this company has already accomplished the not-so-easy task of gaining meaningful share in the dry strip, rapid thermal processing (RTP), and etch markets despite competing with giants like Lam Research (LRCX), Applied Materials (AMAT), and Tokyo Electron (TOELY.PK).

While 2013 has proven to be a very disappointing year for semiconductor equipment orders (and much like waiting for Godot), I don't believe this stagnation is sustainable. Foundries and chip companies can only delay orders and repurpose older equipment for so long. With that, I believe orders will begin to recover in late 2013/early 2014 and bring Wall Street back to the view that Mattson has the collection of tools and technology to challenge its prior record revenue levels - an achievement that I believe could take the shares to $3 or above.

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Mattson Technology: A High-Beta Play On 20nm And Below

Investopedia: Applied Materials Still Waiting For Orders To Materialize

Applied Materials (Nasdaq:AMAT) is an interesting company (and stock) today. With 3D chips on the way, it looks like the semiconductor equipment industry is looking at both a large increase in orders and a change in the sort of equipment that chip companies will need to stay on the leading edge. With strong share in equipment categories that should be essential to FinFETs, Applied Materials should be looking some strong years. But as this quarter highlights pretty clearly, there are a lot of unknowns about timing and investors are still a little hesitant about bidding up these shares ahead of the next cycle.

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Seeking Alpha: CVD Equipment - Certain Risks And Potentially Significant Returns

I'm a fan of so-called repurposed technologies - technologies that were developed for one industry or application and are then introduced into new areas. In that sense, I'm intrigued by CVD Equipment's (CVV) attempts to bring chemical vapor deposition, a technique/technology long used in semiconductor manufacturing, into areas like solar power, LEDs, med-tech and nanotechnology. While the technologies are different, it's a basic approach that has worked for other companies like FEI Company (FEIC).

Unfortunately, while the basic concept of applying very thin layers of active materials to surfaces holds significant potential in many different end markets, there are many ways to skin a cat and CVD's tiny revenue base suggests that the company hasn't really made major commercial inroads yet. Applications in carbon nanotubes, nanowire, and graphene likewise hold huge theoretical potential, but there are many miles to go before it becomes anything like commonplace or commercial in scale.

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CVD Equipment - Certain Risks And Potentially Significant Returns

Investopedia: ASML And The Obvious - Weak Trends And A Bid For Cymer

In contrast to Applied Materials (Nasdaq:AMAT), which has repeatedly made moves and comments that have left investors scratching their heads, ASML (Nasdaq:ASML) continues to operate and report along highly predictable lines. Although there's evidence that industry conditions are even weaker than previously supposed, ASML didn't really surprise with its third quarter earnings, nor its announcement that it's acquiring Cymer (Nasdaq:CYMI). What is frustratingly less obvious, is what constitutes a fair price to pay for ASML today.

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Investopedia: Still Little Good News From Applied Materials

Two-thirds of the way through 2012, it's pretty clear that not only were expectations for a semiconductor and semiconductor equipment recovery wrong, they were off by a wide margin. As Applied Materials (Nasdaq:AMAT) continues to see business erosion, it has to test the patience of even the most loyal or long-term shareholder. While spending will recover someday and the shares will have their day again, the shares are likely to be volatile in the short term.

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Investopedia: A Melancholy Farewell to FSI International

There are two kinds of investors - those who've watched a great idea slip away and liars. In other words, it's just part of the nature of investing that eventually you're going to identify a great stock and somehow, for some reason, not buy it before its big move. With today's news that Tokyo Electron is buying up-and-coming semiconductor equipment company FSI International (Nasdaq:FSII), I add another stock to that not-so-illustrious list.

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Investopedia: Volatility Is The Price Of Opportunity At FSI International

Financial writers love to write articles that talk about how if investors had simply bought "Super-Duper Tech Stock" back in the earliest days and held on tight, they'd be sitting on windfall profits and debating which island to buy for their retirement. What those articles often fail to mention is that the road from small up-and-comer to successful growth stock is never straight or smooth; there are bumps, potholes and detours along the way and some of them are real doozies.

That is worth remembering when it comes to wafer cleaning equipment company FSI International (Nasdaq:FSII). The volatility in growth and guidance over the past few quarters highlights several key points about this stock - there is real growth potential here, but the company is exceptionally vulnerable to any wobble in orders.

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Investopedia: KLAC Looking To Click With The Current Chip Cycle

KLA-Tencor (Nasdaq:KLAC) has a lot of what investors ought to look for when shopping for stocks for their portfolio. The company is a leader in its space (with greater than 50% market share), posts excellent relative margins and continues to simultaneously re-invest in the business without being miserly towards shareholder capital.

All of that said, KLA-Tencor is a semiconductor equipment company and more than a decade of positive cash flow doesn't erase the cyclicality of this sector or this business. While ever-smaller circuits increase the demand for more sophisticated equipment, predicting the peaks and valleys of the cycle is notoriously difficult and investors have started to get a little more cautious.

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Investopedia: There's Still Time To Buy FSI International

The semiconductor sector has looked a bit more wobbly of late, but the odds still seem to favor a pick up in activity and orders in the semiconductor equipment space. Investors who want to make a high-risk/high-reward play on the sector should still consider FSI International (Nasdaq:FSII). While this tiny company's market share in the wafer cleaning space is still tantamount to rounding error, solid order growth speaks to a more interesting future.

Q2 Results - Plenty of Progress, Plenty of Work to Do 

FSI's second quarter highlights some of the pluses and minuses of this almost unfollowed story. Revenue rose 25% this quarter and handily surpassed sell-side analyst estimates. In point of fact, business was even a little better than it looked, as the company shipped two Orion systems that it was not able to recognize as revenue for the quarter.

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Seeking Alpha: FSI International - This Small Semiconductor Company Could Clean Up

It has already been a fairly solid year for many companies in the semiconductor equipment space. With guidance from major players like Applied Materials (AMAT) and ASML (ASML) suggesting that dawn is breaking and the merger between Lam Research (LRCX) and Novellus (NVLS) hinting that business is getting back to normal, investors seem to be willing to consider risky stories again.

That could set up the right sort of one-two punch for investors in FSI International (FSII). Like many other small equipment vendors, FSI was hit hard by the downturn in equipment spending. Unlike some of those small peers, though, FSI is coming into a cyclical upswing with a new product and the potential for some real sales momentum. Couple that with the fact that this stock is barely followed and has about 10% short interest, and it may not take much for this stock to do even more in 2012.

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Investopedia: Lam Snaps Up Novellus

Given the incredibly cyclical nature of semiconductor capital equipment spending and the growing power of a relatively small number of buyers, consolidation just makes sense. While Applied Materials (Nasdaq:AMAT) has been more active of late in buying companies, Lam Research (Nasdaq:LRCX) has stepped up in a big way with an offer for Novellus Systems (Nasdaq:NVLS).

The Deal
Lam announced that it had reached an agreement to acquire Novellus in a $3.3 billion all-stock deal. Lam will give 1.125 of its shares for each Novellus share - a deal which imputes a value of $44.42 per share for Novellus based on pre-announcement prices. That price is a 28% premium for Novellus, but only about 2.3 times trailing sales - a modest discount to historical multiples and a definite discount to the recent Applied Materials - Varian deal.

If the deal goes through as expected, Lam shareholders will own 58% of the combined company, and Lam intends to launch a $1.6 billion share repurchase to neutralize some of the impact of the deal. (For related reading, see The Merger- What To Do When Companies Converge.)


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Investopedia: Applied Materials Still Digging For Bottom

Right up there with "it's different this time" in the lexicon of dangerous Wall Street sayings, is "how much worse can it get?" When it comes to Applied Materials (Nasdaq:AMAT) and its solar and flat panel businesses, apparently the answer is "a whole lot worse." Although recovery in semiconductors is arguably in sight, it seems likely that analysts and institutional investors are going to be more interested in names like KLA-Tencor (Nasdaq:KLAC), Novellus Systems (Nasdaq:NVLS) and ASML (Nasdaq:ASML), until Applied Materials proves convincingly that it can pull out of this nose-dive.

A Sour End to a Tough Year  

Not so long ago, I publicly wondered as to whether Applied Material's forward guidance was one of those kitchen sink situations, where management just wanted to get all of the negativity out of the way. Apparently, the answer is "no," as the fourth quarter was not very strong, and the company's forward guidance was not encouraging.

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Investopedia: Waiting For Applied Materials To Wash Out

One of the frustrating parts about following semiconductor and semiconductor equipment stocks is that no two cycles are exactly alike. Right now, Applied Materials (Nasdaq:AMAT) is in a place where the industry is still trying to find the bottom in orders, and companies like ASML (Nasdaq:ASML) have started to suggest that orders will bottom out to maintenance levels late this year or early next year. Applied Materials looks cheap, but it did a quarter ago and the quarter before that, and investors may want to wait for signs of stabilization in orders before taking the plunge.

A Solid Third Quarter ... Sort Of
Applied Materials has been in a weird place for a little while now, lowering order guidance and yet still managing to do a little better than it leads investors to expect. So, too, again this time. Revenue fell 3% on a sequential basis (and rose 11% year over year), enough to beat the average estimate by $100 million and the high end of the range by $50 million. Business was relatively balanced, with the large Silicon Systems category down about 4% sequentially.

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Investopedia: Playing The Applied Materials Rollercoaster

Semiconductor equipment giant Applied Materials (Nasdaq:AMAT) is a frustrating name in many respects. Nobody disputes that AMAT is a leading name in the equipment that companies require to manufacture semiconductor, LEDs, flat panels and solar films. On the other hand, while the company's revenue and cash flow base has chopped upwards, the stock has yet to break out of a ten-year downward trend. That makes this stock a challenging trade-off between quality, valuation and sentiment. 


A Solid Start to the Fiscal Year
At least AMAT is getting this fiscal year off to a decent start. Revenue rose 45% from last year, but dropped about 7% from the prior quarter, and beat the average analyst guess. The underlying revenue mix was a bit more volatile; the company's core semiconductor business was up slightly, while the display and solar businesses fell off sequentially.

Profitability was not bad. Gross margin (on an adjusted basis) stayed sequentially consistent, as did the company's operating margin. That's not given that it is not at all uncommon for companies like Applied Materials to see a sharper falloff in profits on lower sequential revenue.


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