Business vs. Stock Recoveries

You've probably read about it yesterday but yet another sell-side analyst upgraded a group of SCE companies. I have to tell you my friends in the business are very cynical about this. And yes, I know that Kulicke & Soffa (KLIC) stated that their business has picked up and that they are often noted as a canary in the coal mine for the chip industry - which, by the way, was a designation they were pegged with right here many, many years ago.

During our discussion of the upgrades one grizzled industry veteran shared the following:

In my opinion the equipment market will turn up when all the following happens (in order)

1. Chip makers see enough upswing in orders to actually turn on unused tools
2. Chip makers stop taking parts from unused tools and are forced to buy new spares
3. Chip makers unwrap tools still in crates and begin to use (dirty little secret of the industry)
4. Chip makers get marginal utilization of 80%
5. Chip makers actually make money at 80% utilization rate
6. DRAM makers keep their pledge to shutter unprofitable fabs and don't decide to give them one last shot.

....then the equipment guys will see enough orders to warrant an uptick in their stock.

The history of what it takes to move stocks and what it takes to move the semiconductor cycle have increasingly become different things. I'm not going to question whether or not the stocks will lead the cycle - they will - but most likely after numerous false starts. If you are driven to invest based on fundamentals that is not good enough. All one needs to do to see that as the case is to note the "buy them for the turn" table pounding that has been going on for the last two years.

The question then becomes: "By how much should the stocks lead the cycle? 6 months, 12 months, 24 months?"

If you are trading the beta, at least the bit of beta that remains in the stocks, it doesn't matter. If you are taking a little longer term approach and actually investing for a cycle play then it does.

Here are a few more questions and thoughts we've been discussing on the mailing list:

Is the worst over?

Coming from near zero, I’d say yes. This cycle is very different for a host of fundamental reasons and though we are getting a bounce off the bottom it doesn't tell us anything about the shape of the recovery.

Will the industry even get close to peak margins again? That's highly doubtful. Looking up and down the chain suggests that a weakened semiconductor business will continue to weaken the capital equipment business.

Which brings you to another set of questions that will hover over the industry as this cycle (if you want to call it that) develops: Are there more consolidations ahead? For what reasons, and what companies?

Yeah, this could go on all day. The sense here is that even more realities will surface in the next few quarters. That should make for a very interesting summer in semiconductor land.