Bearish comments from analysts at JP Morgan and Robert W. Baird
this week regarding tech spending has put an already-weak sector
under even greater pressure. Major tech names like
Intel (Nasdaq: INTC)
Dell (Nasdaq: DELL)
are retreating from recent gains and some tech stocks are quickly
falling into the abyss.
On Tuesday, shares of
Applied Materials (Nasdaq: AMAT)
Seagate Technology (
Symantec (Nasdaq: SYMC)
all hit 52-week lows. For existing shareholders, it's fair to
wonder if it's time to cut their losses. And for investors that
have avoided this sector as it has tumbled, do these
newly-cheapened stocks signal it's time to jump in? Let's take a
One of the key challenges for all tech stocks involves the steep
peaks and dips in revenue and profit streams. With such robust
swings, investors always apply relatively low multiples. In the
area of semiconductors, investors are often even more wary, as
capital spending cycles enter into boom and bust cycles with
alarming frequency. Applied Materials, for example, saw sales
plunge -38% in fiscal (October) 2009, yet is in the midst of a
fresh growth spurt this year that should boost sales +70% to +80%.
But fear springs eternal for this sector, and investors are already
bracing for the next plunge. Perhaps that fear is quite premature.
After all, capital spending for advanced semiconductor equipment --
for which Applied Materials is the acknowledged global leader -- is
often a function of the cash customers have at their disposal.
Right now, Applied Materials' customers are fattening their balance
sheets again after a string of solid results from chip makers.
Looking ahead, analysts still think Applied Materials will see
sales grow in fiscal (October) 2011, perhaps in the +10% to 20%
range. That may prove to be optimistic or pessimistic, but one
thing is for sure: the company generates loads of cash in good
times or bad. Sure, it lost $235 million in
free cash flow
in 2009, but it generated $6.7 billion in positive free cash flow
during the previous five years. It would take an absolute plunge in
global chip equipment spending for Applied Materials to move back
into the red in terms of free cash flow.
In a bid to please investors, Applied Materials recently shut down
its money-losing SunFab unit that makes thin-film solar panels.
That move is expected to boost profits and once again tighten the
company's core focus on the semiconductor business (although it
will retain some exposure to the solar industry). That move should
allow gross margins to rise back up next year into the mid 40%
range from a current 39%, according to Needham & Co. Operating
margins should also rebound back into the low 20% range. Yet shares
have moved even lower since that July 21st announcement and are now
at levels last seen in 2003 (excepting the early 2009 swoon which
cratered many stocks).
Assuming sales rise at a moderate pace in 2011, as analysts
currently expect, then free cash flow could approach $1.5 billion
-- roughly in line with what Applied Materials generated in 2006
and 2007. Back then, shares traded in a range of $15 to $25 -- well
above the current price near $11.15.
As is the case with many tech stocks these days, Applied Materials
can only rely on one catalyst to support shares: stock buybacks.
The company's share count has already shrunk from 1.7 billion
shares in 2004 to a recent 1.34 billion. The company could continue
buying back 100 million shares annually without cutting into
R&D spending or its $3 billion in cash and investments.
Applied Materials is expected to report third quarter results next
Wednesday, August 18th. Management noted in July that the quarter
was faring well, and if recent quarterly conference calls are any
guide, management should again speak of a still-rising
of orders. Perhaps that will be what it takes to get shares out of
the summer doldrums.
This hard-disk drive maker is also a victim of lousy sentiment
toward the entire industry. Those bearish comments noted earlier
from JP Morgan and Robert W. Baird specifically cited concerns
about a slowdown in spending on PCs and servers. Seagate, which has
exposure to both volume and pricing (both metrics are good when
demand is strong, and bad when they're not) surely can post erratic
numbers. When business was lousy in fiscal (June) 2009, the company
barely broke even in terms of free cash flow. Yet in the
just ended, free cash flow surged to more than $1 billion. But the
recent quarterly results also highlighted an emerging slowdown in
demand, thanks in large part to cautious spending trends in Europe.
Yet even as sales weaken a bit, Seagate remains highly profitable.
Analysts had been expecting
in the $3.60 range for both fiscal 2011 and 2012, but thanks to the
incipient slowdown, have lowered those forecasts by a little more
than a dollar to about $2.40. Seagate's shares trade for less than
five times those lowered 2011 and 2012 profit projections.
To be sure, few positive catalysts exist in the near-term, so this
stock is of much greater appeal to deep value investors than growth
investors. Yet if the
does begin to turn around, Seagate is a very high
stock and could quickly double from current levels. Right now, few
are envisioning such a scenario, as evidenced by Tuesday's new
This security software maker has been in the doghouse ever since it
acquired computer storage firm Veritas in 2005 for more than $13
billion. Investors didn't see the synergies of the deal back then,
and they still don't. Adding insult, results at both of these
disparate divisions began to lag their respective rivals, perhaps
due to management's lost focus.
Even as organic growth has been lacking, Symantec has been a free
cash flow machine, routinely spitting out about $1.4 billion in
free cash flow, year after year. To boost growth, the company has
put that prodigious
back into play, recently acquiring a security software division
Verisign (Nasdaq: VRSN)
for $1.3 billion. At least this deal has real synergies.
Symantec's ever-sinking stock is the result of tepid guidance
issued in late July making clear that key customers were taking a
longer time to commit to big new contracts. Like Seagate, Symantec
has become a company with dim top-line prospects, but still-robust
bottom-line prospects. And in this market, that trade-off holds
Action to Take -->
Interested investors may want to check out Applied Materials'
conference call next Wednesday to get the latest outlook on this
seemingly moribund sector.
Applied Materials is the healthiest among these three stocks,
though with shares trading for a little over 15 times projected
profits, it lacks the absolute rock-bottom valuations seen with
Seagate (4.5) and Symantec (9.6). All three of these companies are
either first or second in the industries they operate and should
rise anew when investors rotate back into the tech sector.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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