Monday - December 5, 2005

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After years of struggling through an industry down-cycle, semiconductors appear to be strengthening again. To help us sort out where we should take this knowledge, we spoke with senior semiconductor analyst Ken Nagy to guide us through.

How were third quarter earnings for the semiconductor industry in general? Did fabrication plants outperform other sectors?

We believe that the semiconductor manufacturing industry has begun a new up-cycle, after reaching a trough in the first quarter of 2005. The robust bookings from the last three consecutive quarters are an early indicator. That said, there are two camps here:

If a company has earned its profits by ratcheting up capacity, then it was an excellent quarter. On the other hand, if a company has earned profits as a result of semiconductor spending, those companies may be waiting another quarter or two for their good news, as managers have limited spending.

More. . .

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Zacks Equity Research continued...

The chip fabrication plants, or "fabs," remain a strong player in the industry as costs have shot up. Capital outlays for bringing the most advanced fabrication plants on line have increased from $1 billion in 1997 to $2.75 billion in 2003. This is expected to accelerate to $6 billion by 2007. These increasing costs stem from higher price tags on the highly sophisticated production equipment that enable semiconductor manufacturers to produce state-of-the-art chips.

Do you expect the up-cycle for semiconductors to continue through 2006? How long do you anticipate it will last?

A few years ago, we would have simply looked at corporate spending, but we believe that there is a fundamental shift in the semiconductor industry from corporate IT to consumer demand. According to the SIA, more than 50% of the $213 billion in 2004 semiconductor sales went into products purchased by consumers, rather than corporate IT departments. This proportion will continue to grow in the years ahead, as consumers all over the world are captivated by the richness and portability of digital media. Advances in computing, digital media processing and wireless technology are enabling the industry to create lifestyle-changing devices and gadgets that could only be imagined a few years ago. The changing nature of customers will affect every aspect of the business, from product design to marketing and demand forecasting.

There has been a bit of M&A activity in the industry. Do you see this continuing?

In short, yes I do. First off, semiconductor firms as a whole have very high cash balances and low debt at this point in time, which is creating many good opportunities to invest in other technologies by acquiring companies that will help spread their product offerings. Consider also that it is much easier to buy a technology through a merger than to spend on R&D that often does not lead to anything.

What Buy recommendations would you make for us today?

We currently have a Buy on FormFactor (FORM), which is the market leader in advanced wafer probe cards used to test semiconductor wafers during the manufacturing process. The company has a very strong growth profile. September quarter revenue and EPS were well-above expectations. Bookings were up 9% sequentially to an all-time high. The company is no longer capacity-constrained, and we expect margins to expand from here. The company’s technology is leveraged towards leading-edge 300mm and sub-110nm nodes, which are ramping quickly throughout the industry. Production capacity will be expanding throughout the year as the company's new plant ramps capacity. This new plant began shipping product during the second quarter, accounting for 15% of total sales. The plant is expected to run at full capacity by the end of 2005. Since both plants are operating during the transition, there are non-permanent incremental costs that will disappear, thus improving margins.

What should investors keep mindful of about semiconductors as 2005 winds to a close?

It's not just supply and demand that are important in semiconductors. Sometimes technology can take the industry on a wild ride. Take, for instance, the case of Varian Semiconductor (VSEA), which competes in the semi-tool industry. The semi-tool industry can be divided into high energy/low current products, medium energy/medium current products and low energy/high current products. The fastest-growing category - high current - accounts for 50% of total industry revenue, medium current accounts for about one-third of the total, and high energy is about 17%. Varian sells in all spaces, and its tools cross the segments, using common parts and software tools, and affording valuable cost-saving opportunities.

As technology nodes get smaller (less than 90nm), batch technology breaks down and destroys some chips, which hurts yields. This is a relatively new problem at smaller technology nodes, yet once introduced many companies have gone back and checked old problems, only to find out that this may have been a problem at larger nodes as well. Varian, on the other hand, uses a double-magnet ribbon system which is a single wafer producer. The Varian product does not damage the chips. Largely due to this, VSEA has grown its market share dramatically in the last 6-12 months, while the rest of the industry is now playing catch up.

So issues such as this - how new technologies can have unforeseen consequences - should be a major factor for investors getting into semiconductors. The best method is to notice when certain companies adapt to a particular technology favorably.

Ken Nagy is a senior analyst covering the semiconductor industry for Zacks Independent Research.

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MORE FROM ZACKS EQUITY RESEARCH…

BULL OF THE DAY

Cymer, Inc. (CYMI) - Leading its Semiconductor Segment. For full Zacks research report, click here.

 
BEAR OF THE DAY

Synopsys, Inc. (SNPS) - Weaker Growth than Competitors. For full Zacks research report, click here.

 
ZACKS INDUSTRY OUTLOOK

BioTech Research Paying Off

BioTech companies should have a meaningfully better second half of the decade. More...

 
EARNINGS & SECTOR UPDATE

Finishing Up the Third Quarter

Dirk Van Dijk, Director of Research, expects a somewhat better performance for mid- to large-caps in 2005, but a better relative earnings performance in 2006 for mega-caps. More...

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Zacks.com is proud to share with you some of the best trading strategies that truly allow you to Profit from the Pros. Today we highlight...
 

Profit Tracks: Return on Equity

This Profit Track strategy uses Return on Equity (ROE) to discover solid stocks. ROE is one of the quickest ways to gauge whether a company is creating assets or gobbling up investors' cash.

One of the quickest ways to gauge whether a company is creating assets or gobbling up investors' cash is to look at their ROE. This fast moving Profit Track returned an impressive +30.3% in 2004. In 2005, it continues to outperform the S&P 500 by a wide margin.

 
Here are four stocks that make the grade for the Return on Equity Profit Track:

Brown Shoe Co.(NYSE: BWS) has a ROE of 13.10 and a price to sales ratio of .34. Last week, the company posted fiscal third-quarter adjusted earnings of $1.21 per share, beating the consensus estimate by about 22% and surpassing last year's result. The company said earnings exceeded projections, as its Famous Footwear division had a record quarter for sales and earnings supported by solid margins. Continue your research on BWS at: http://at.zacks.com/?id=2254.

CommScope, Inc. (NYSE: CTV) reported third-quarter adjusted earnings of 34 cents per share in late October, surpassing the consensus estimate by almost 26% and improving on last year's result. The company commented that it managed costs effectively, achieved operating profits in all segments, including the Carrier segment, and expanded overall operating margins. CTV meets the criteria of this Profit Track with a ROE of 10.47 and a price to sales ratio of .88. Continue your research on CTV at: http://at.zacks.com/?id=2255.

Giant Industries, Inc. (NYSE: GI), a petroleum refiner, has an appealing valuation as indicated by its ROE of 27.38 and a price to sales ratio of .24. In early November, the company announced third-quarter earnings of $3.38 per share, exceeding the consensus estimate by nearly 13% and soaring past the year ago total. The company mentioned that strong operating and financial performances from each of its strategic business units contributed to the overall financial results in the third quarter. Continue your research on GI at: http://at.zacks.com/?id=2256.

William Lyons Homes (NYSE: WLS) sports the highest ROE of 46.30 on this Profit Track list. In early November, the company released third-quarter earnings of $4.39 per share. The result topped analysts’ expectations by roughly 39%. The company stated that it is pleased by the 27% increase in the number of net new home orders to 834 for the third quarter of 2005 as compared to 659 for the third quarter of 2004. WLS has a price to sales ratio of .58. Continue your research on WLS at: http://at.zacks.com/?id=2257.

To see the full list of stocks that currently pass this winning screen, go to: http://at.zacks.com/?id=2258.

All the Profit Track strategies were created and backtested using the Research Wizard software from Zacks Investment Research. If you like this screening strategy, but want to narrow down the list of stocks and even improve the performance, then you should start a free trial to this powerful stock picking tool. Learn more about the Research Wizard free trial offer and our new special report “Top 10 Stock Screening Strategies” at: http://at.zacks.com/?id=2307

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SCREEN OF THE WEEK

Finding Growth Stocks at Excellent Values

Kevin Matras shows you how to find great growth stocks at an excellent value: http://at.zacks.com/?id=2259.
 

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The Zacks #1 Rank (Strong Buy) list is always limited to approximately 220 stocks. Four stocks that are currently included in this elite group are: Alliance Data Systems, Cal Dive Int’l, Kopin Corporation and RF Micro Devices.
 

Alliance Data Systems Corp. (NYSE: ADS) released third-quarter earnings of 42 cents per share in mid-October, which topped the previous year’s 31 cents. The company said momentum continued to build for future quarters from significant new client wins and contract extensions. ADS was comfortable raising its full year 2005 earnings guidance to $2.00 - $2.02 versus the $1.92 - $1.95 stated previously. Analysts have current estimates pegged at $2.03 per share, which is nearly 4% above two months ago levels. Continue your research on ADS at: http://at.zacks.com/?id=2262.

Cal Dive International, Inc. (NASDAQ: CDIS) earnings estimates for the year ending December 2005 climbed 27 cents, or about 8%, from one month ago. For the 2006 year, current estimates are $4.92 per share, which is almost 16% above one month ago levels. In early November, the company reported third-quarter earnings of $1.05 per share, exceeding the consensus estimate by approximately 22% and improving on last year’s 59 cents. The company mentioned that due to the strength of its business model, it produced another record quarter for both earnings and cash flow. Continue your research on CDIS: http://at.zacks.com/?id=2263.

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Zacks Rank continued...

Kopin Corp. (NASDAQ: KOPN) earnings estimates for the year ending December 2005 jumped seven cents, or nearly 78%, over the past 30 trading days. Full year 2006 earnings estimates increased four cents, or nearly 31%, over the same time period. In early November, KOPN announced third-quarter earnings of eight cents per share, reversing last year’s loss of two cents and surging past the consensus estimate by 700%. The company noted that it delivered record performance on the top and bottom line. Continue your research on KOPNat: http://at.zacks.com/?id=2264.

RF Micro Devices, Inc. (NASDAQ: RFMD) posted fiscal second-quarter pro forma earnings of four cents per share in late October, outpacing analysts’ expectations by about 33% and reversing last year’s loss. The company noted that during the quarter it experienced record order activity, driven by increased demand for its power amplifiers, POLARIS^TM TOTAL RADIO^TM transceiver chipsets and Bluetooth® products. Earnings estimates for the year ending March 2006 moved up by six cents, or 60%, from two months ago. Continue your research on RFMD at: http://at.zacks.com/?id=2265.

To see the full list of Zacks #1 Rank stocks (approximately 220 stocks), go to http://at.zacks.com/?id=2266.

The Zacks Rank is a powerful stock indicator whose #1 Strong Buy stocks have risen by an average annual return of 33% since 1988 versus 11.8% for S&P 500.

To help you fully understand how the Zacks Rank works and, more importantly, how you can profit by using the Zacks Rank, we have created a free report - The Zacks Rank - Harnessing the Power of Earnings Estimate Revisions. This valuable information is available at: http://at.zacks.com/?id=2267.

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Here we cast the spotlight on a timely Featured Expert commentary that recently appeared on Zacks.com.

 
Charles Norton & Allen Gillespie, Editors of Supernova Stocks
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For some time now, the Fed has included a sentence in its release that says, ''With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.''

What that means, in plain English, is that the Fed was telling the market that it was intent on taking calculated, careful steps to continue raising interest rates. Unconcerned about inflation, the FOMC policymakers didn't feel pressured to quickly hike rates, but intended on taking an unknown number of 25 basis point baby steps, persistently jacking them up.

It's now clear that the Fed might be in the final innings of its interest rate increases (to borrow an analogy from Dallas Fed President Richard Fisher). When the minutes of the November 1 FOMC meeting were released yesterday, they showed some members of the committee, worried about the risk of raising rates too much, discussed changing their outlook for interest rates.

Whether there are one or two more hikes in the future, Charles Norton and Allen Gillespie are not certain. But the language that has intimated that the road of removing accommodative monetary policy is a long one is likely to be changed.

Of course, there are those that believe that rates were kept too low for too long, and as a result, inflation will be a big problem down the road. What does best under that scenario? Gold. While the purchasing power of the dollar is eroded by high inflation, gold maintains its value.

It's no surprise, then, that one of the best performing industry groups right now is Metal Ores-Gold/Silver.

Norton and Gillespie are adding some exposure to this group by buying shares of Randgold Resources (NASDAQ: GOLD).

Another group noticeably absent from Norton and Gillespie’s model portfolio is the investment bankers, which pretty much all look good. They are adding Deutsche Bank (NYSE: DB) to their portfolio.

 
About Norton and Gillespie’s Supernova Stocks newsletter

Supernova Stocks is an independent investment newsletter advisory that is committed to finding the most fundamentally superior and technically sound stocks that have the greatest growth prospects. Supernova Stocks focuses on the very best companies in top performing industry groups that have some institutional sponsorship, but are largely under-owned. Supernova Stocks is led by Charles Norton, CFA, a professional asset manager. http://at.zacks.com/?id=2348
 

OTHER TOOLS FROM ZACKS

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At the heart of Zacks Investment Research is the Zacks Rank investment philosophy that continues to vastly outperform the market. Our Zacks #1 Ranked (Strong Buys) have produced the following results for investors:

• +33% average annual return since 1988 versus +11.8% for S&P 500
• Outperformed S&P 500 in 16 of the last 17 years
• +43.8% total return from 2000 to 2002 - the worst bear market in over 60 years.
• +18% in 2005 (through September 30)

And just as importantly, the Zacks #5 Rank stocks (Strong Sell) List has alerted investors as to which stocks to dump from Their portfolios to avoid unnecessary losses.

To truly take advantage of the Zacks Rank, you need to first understand how it works. That's why we created the free special report: Zacks Rank Guide: Harnessing the Power of Earnings Estimate Revisions. Download a free copy now to prosper in the years to come by visiting: http://at.zacks.com/?id=2309.

Or view the full list of Zacks #1 Ranked stocks at: http://at.zacks.com/?id=2266.

FREE PORTFOLIO TRACKER

Do you believe that these events affect stock prices?

• Broker Recommendation changes
• Earning Estimate revisions
• Earnings Announcements
• Zacks Rank changes

If you answered yes, then how are you staying on top of these changes for your stocks? If you are one of the 45,000 investors who wake up every morning to the Daily Portfolio Updates emails from Zacks.com, then you are all set. If not, then sign up now to get this vital information sent to you daily and improve your portfolio's performance. Did we mention it's free? Get started now by going to: http://at.zacks.com/?id=2310

We hope you enjoyed this issue of "Profit from the Pros", And we look forward to visiting with you again next week.

REFER-A-FRIEND

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Regards and Happy Investing,

Charles Rotblut, CFA

Senior Market Analyst
Zacks.com

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Disclaimer: Past performance does not guarantee future results. Investors should always research companies and securities before making any investments. Nothing herein should be construed as an offer or solicitation to buy or sell any security.

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