NEW YORK (CNN/Money) -
Applied Materials surprised even the bulls with its second-quarter results. The headline was good: The chip-equipment giant beat estimates by a penny.
More impressive to analysts was the increase in new orders, up 51 percent. "We are seeing strong demand...as the semiconductor industry begins to recover and customers increase their capital spending," CEO James C. Morgan said in a statement (see more on Applied Materials' results).
Investors were already expecting good news -- if not quite this much of it. Applied Materials (AMAT: up $0.46 to $24.26, Research, Estimates) racked up a 4 percent gain in trading Tuesday in advance of the earnings report -- on top of an 8 percent gain on Monday -- as a number of analysts came out and said they expected the company to post numbers better than they were, er, expecting. The stock added another 5 percent in after hours trading following its earnings release.
Applied Materials' cheery results cap what's been a virtual lovefest for the chip sector. On Monday, Thomas Weisel analyst David Readerman cheerfully announced that "the spring is loaded for a tech recovery," with corporate technology spending apparently "stabilized" and newly lean and efficient chip companies showing particular promise.
On Tuesday, Robertson Stephens analyst Eric Rothdeutsch upgraded Intel (INTC: down $0.25 to $28.41, Research, Estimates) to a "buy" from a "market perform," saying he was heartened by "solid product and process execution" and Intel's apparent unwillingness (at least for the moment) to cut prices on Pentium 4 chips. Inspired by Rothdeutsch's upgrade, investors upgraded Intel's stock some 6 percent in Tuesday trading. Many other chip names, among them Altera (ALTR: down $0.15 to $19.00, Research, Estimates), Broadcom (BCOM: Research, Estimates) and Applied Micro Circuits (AMCC: up $0.12 to $6.52, Research, Estimates), shot up even faster and more furiously.
Looking for love...
To some degree, this enthusiasm is understandable. The chip-equipment business does indeed seem to be staging a recovery of sorts. In March, the industry book-to-bill ratio rose above 1.0 for the first time in more than a year, according to industry group Semiconductor Equipment and Materials International (meaning that order bookings were finally outpacing product billings). Applied Materials' upbeat earnings report confirms that the news looks good for now.
The real question is whether the good news can last. Indeed, UBS Warburg analyst Byron Walker worried in a recent research note that any uptick in orders for Applied Materials could be the result of "an intense and brief upcycle rather than a slow buildup to a robust 2004 and 2005."
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The company's new orders are impressive. But orders can get canceled if there isn't a strong and sustained increase in demand. The last chip upcycle was driven by rapid growth in the Internet and cell phones. It's not clear yet what, if anything, might drive a comparable increase in demand this time around.
Given all that, chip stocks don't exactly scream "bargain" at current prices -- even if you assume solid increases in earnings power once the recovery begins to pick up steam. Intel, though joined at the hip to the slow-growing PC business, trades for more than 40 times estimated 2002 earnings (and nearly 30 times 2003 estimates).
Broadcom, admittedly a more speculative bet, trades for 80 times 2003 estimates (it isn't expecting a profit this year). Applied Materials, meanwhile, sports a triple digit P/E based on 2002 estimates. While the company's E is ultimately expected to start catching up with the P in a big way, the stock still trades for 40 times estimates for the fiscal year ending in October 2003. Applied Materials is one of the tech world's heavy lifters, and its earnings report was certainly impressive. But its share price already reflects some pretty high hopes indeed.
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