Thursday, July 08, 2010

Nanometrics (NASDAQ:NANO): INTC Giveth, and INTC Taketh Away—Downgrading to Perform - Oppenheimer

Oppenheimer's Semiconductor team is downgrading Nanometrics (NASDAQ:NANO) to Market Perform from Outperform while lowering their target to $10 (prev. $13).

The firm notes their downgrade of NANO is plain and simple: They upgraded the stock in August of 2009 (@ $3.55) on proprietary data points indicating the company had been awarded INTC's 22nm thin-film/optical critical dimension (OCD for short) metrology business. Based on the magnitude of this business, they saw clear visibility for $1-plus/share in earnings in 2010/2011. Until recently, this has been their consistent thesis on NANO.

Recently, however, Opco's checks suggest that upon encountering technical issues during initial trial/pilot runs at 22nm, INTC has turned back this decision, partially. With persistent issues related to tool-to-tool matching (i.e., measurements made on one tool not quite matching same measurements on another tool), INTC has relegated more critical thin-film/OCD applications in/around the lithography bay to KLAC. KLAC was the incumbent supplier, and has an installed base of thin-film/OCD tools already at INTC for 45/32nm.

Roughly, the firm estimates that the total thin-film/OCD tool opportunity at INTC for 22nm totals ~80 tools, with half allocated for litho applications, the other half for etch. Thus, they estimate NANO's loss to be 40 tools (give or take) in 2011. Given INTC is presently a 20%-plus customer (exceeded only by Samsung), the impact in terms of percentage and absolute value materially impacts their 2011 model. Taking out $30M in revenue, and assuming 1) percent gross margin on INTC sales is 40%, well below its corporate average of 50%-plus, and 2) no offset out of operating expenses as support of INTC sales offers no scaling to the downside, they estimate the earnings impact at ~$0.40/share.

Thus, consistent with a $30M revenue shortfall in 2011, translating to a ~$0.40/share earnings drop in their model for 2011, Opco is lowering their FY11 estimate to $0.90 from $1.32

Justifying their Perform rating (vs. Underperform) is the potential for partial offsets: 1) ramp in UniFire for INTC back-end, 2) OCD metrology win at Toshiba and 3) revival of overlay metrology. However, there are already questions on the semi cycle, and share loss makes a specific stock even more questionable.

Notablecalls: This is what I call quality research - new info coupled with a change in thesis.

Note that Piper Jaffray was out very positive on NANO on June 28 reiterating their Overweight rating and $22.50 price target saying that based on their conversations, they believed the Street was underestimating NANO's opportunity at Intel:

NANO's OCD opportunity at Intel is likely to be bigger than we thought. We initially estimated that the OCD opportunity at Intel as a $60-$90 million opportunity for Nanometrics in the 22nm node. We now believe that the opportunity is likely to be closer to $90-$120 million. While Intel has taken a few systems for development, we believe the volume is minimal today. We expect shipments for production tools for 22nm to commence in Q4:10. The increase in our estimates for Intel rev for OCD increases our confidence in our CY11E, and we believe that NANO numbers are likely to go up not down moving forward.

I guess Opco's comments will give Piper something to think about.

NANO isn't a big trader but I think the call will create some selling pressure. The stock hasn't done much over the past 6 months (vs. the market decline) or so which seems to indicate that investors were expecting good news out of NANO.

I think the stock is likely to trade towards $10 level today & I would not be surprised to see that level breached. Would not rule out $9.50.

Again, well done Opco Semi team!

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