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We have been watching the semi equipment stocks closely over the last few days and it seems as if our fears have been realized. Over the last five days, shares of KLA-Tencor ( KLAC - Analyst Report ) , Novellus Systems ( ) and Lam Research Corporation ( LRCX - Snapshot Report ) lost 5.9%, 5.9% and 3.8%, respectively.
Moreover, the decline was more pronounced after April 7, when Taiwan Semiconductor Manufacturing Company ( TSM - Snapshot Report ) lowered its outlook on semiconductor unit growth for 2011, citing concerns related to Japan.
We cannot say we are surprised. We have been thinking that the Japan crisis could have a more far-reaching effect on semiconductor manufacturing than immediately met the eye. This is because Japan is not only a significant consumer of semiconductors, but also a significant supplier.
What this basically means is that components coming out of Japan will be in short supply, as we have seen in the case of components for Apple Inc’s ( AAPL - Analyst Report ) iPad. This would mean that the components not coming out of Japan, which are also designed into the iPad (for example) would fall into excess, when the end product did not sell as much as previously expected. This would result in accumulation of component inventories, caution at manufacturers and a lower level of demand overall.
For those lucky companies that do not have direct operations in Japan, there will not be any costs associated with resumption of production and trade. And for those like Texas Instruments ( TXN - Analyst Report ) that are able to transfer most of the manufacturing elsewhere, lead times may not stretch out too much. But others will have to take charges depending on the extent of damage.
The companies that have been worst affected have been tight-lipped about the extent of damage and here the assessment process appears to be ongoing. For equipment companies, this is negative in the short term, since supply to Japan will come to a standstill, with ripple effects impacting spending in other regions as well.
However, it could be a positive longer-term, since Japan will have to rebuild infrastructure, which would prove beneficial for these companies. Therefore, the weakness could be a buying opportunity. Also, some equipment makers, such as Cymer Inc ( CYMI - Snapshot Report ) have seen their strongest competition demolished by the tsunami, so they will continue to enjoy stronger-than-expected demand in the near-to-medium term.
The Zacks Ranks for KLA-Tencor, Novellus, Lam Research and Cymer remain #2, indicating a Buy recommendation over the next 1-3 months.
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