Inside Wall Street: Novellus Is Riding the Tech Rebound

Gene Marcial Inside Wall Street
Gene Marcial Inside Wall Street

With the economy revving up, technology is again at the forefront of investor interest. But with so many tech players, the challenge is picking a sure winner. Most techs have already advanced, including industry leaders Intel (INTC) and International Business Machines (IBM), reflecting the jump in demand for information technology goods and services.

The popularity of devices such as smart phones, 3D flat television screens, and now Apple's iPad computer has required a rapid roll-out of new-generation semiconductor products. This calls attention to Novellus Systems (NVLS), the second largest maker of semiconductor capital gear, such as "deposition" equipment used to deposit conductive and insulating layers on semiconductor wafers to form integrated circuits.

Shares of Novellus have just started to participate in the latest tech rally, climbing from $20 a share on Nov. 30, 2009, to $25 on May 13. It has more to go, say some analysts, who figure the rising tech market could push up the stock to as high as $36 in a year.

Snapping Back

Like most other tech companies, Novellus has had a rough going in the past two years. But it has started to snap back.

"Orders and revenues at Novellus bottomed in the March 2009 quarter, and the company's business since then has been growing," says Zacks Investment Research in a recent note to clients. The recovery in technology markets, particularly the strength at the memory and foundry manufacturers, "has led to very strong revenue and earnings growth in the past three quarters," beating consensus estimates, notes Zacks.

On May 6, it upgraded its recommendation on Novellus to outperform from neutral. For the rest of the year, Zacks expects continued improvement in Novellus' sales, driven by new tech purchases and capacity additions.

"Wall Street is starting to realize Novellus' earnings power," says Y. Edwin Mok, analyst at investment firm Needham, who rates the stock a buy. Of the 17 analysts who track Novellus, only seven so far rate it a buy and eight are neutral on the stock. Two analysts recommend dumping it. Novellus "continues to demonstrate strong operating leverage in this cycle," says Mok, beating estimates over the last four quarters. Gross margin expansion, stable operating expenses, and increasing market share are helping drive up earnings, notes Mok.

An Appealing Discount

Also high on Novellus is Krish Sankar, analyst at Bank of America Merrill Lynch, who notes that the stock trades at a discount to its peers. Major rivals trade at an average of 11 times 2011 earnings estimates while Novellus trades at nine times.

"Given the growth opportunities and earnings leverage of Novellus, we conservatively believe it should trade at least in line with its peers," argues the analyst. Applying a price-earnings ratio of 11 on Sankar's 2011 forecast of $3.10 a share, the stock would be worth $34 a share. Sankar's estimate for 2010 is $2.38, vs. a loss of 88 cents in 2009. Novellus is improving its margins, which should help it achieve profitability that would be higher than those in past economic cycles, says Sankar.

The company's 10 largest customers, including Intel and Samsung, accounted for 71% of sales in 2009. Sankar notes that Novellus' top customers increasingly dominate capital spending among the tech companies. Novellus' major rival in the industry is Applied Materials (AMAT), the worldwide leader in the manufacturer of semiconductor equipment.

A number of large institutional investors have started adding to their holdings, including Eminence Capital, which bought 2.5 million shares as of Feb. 1, 2010, increasing its stake to 5.3%, and Ameriprise Financial, which acquired 3.3 million shares, raising its ownership to 5.2% as of Dec. 31, 2009. Novellus' largest is Fidelity Management, which owns 6.2%, which acquired about one million shares as of Dec. 31, 2009..

For investors seeking a tech stock with continued growth potential but which hasn't yet fully blossomed in the rally, Novellus may be the answer.