Novellus — How to Play Monday’s Earnings Report

Semiconductor equipment maker Novellus (NASDAQ:NVLS) reports earnings for the quarter ending Sept. 30 on Monday. With the semiconductor industry on the downside of a cycle, investors should not expect much from the report.

The allure of technology stocks is simple greed. When times are good and markets are rising, technology shares generally outperform the rest of the market. The flip side is that when times are tough and markets are falling, technology shares fall harder. For Novellus, the turn began in March of this year.

Since that time, shares steadily have drifted lower as business prospects deteriorate. With the company warning of a reduction in sales in early September, Novellus all but confirmed a down cycle. The only question now: When do we hit bottom?

During the past four quarters, Novellus has slightly beat average Wall Street estimates:

Since the June 30 report, analysts have been slashing estimates for the quarter ending Sept. 30 and the full year. Ninety days ago, the expectation was for Novellus to make 87 per share. Today, the estimate is for the company to make 68 cents per share.

For the full year, the company is expected to make $3.05 per share. Ninety days ago, the estimate for the year was at $3.58 per share. In 2012, earnings are expected to drop to $2.67 per share, versus ninety days ago, when the 2012 estimate was for $3.72. At current prices, shares of Novellus trade for 10 times 2011 estimated earnings.

Click to EnlargeThe drastic changes in outlook have pushed shares of Novellus another leg lower. The stock is down 18% since the beginning of July. During the past year, the stock is slightly higher.

Novellus faces great risks heading into Monday�s report. The volatility of earnings estimates during the past three months has only increased uncertainty, and the company now is on record for noting a slowdown in customer spending. Not that any of this is surprising given the circumstances, but it should be troubling for anyone looking to own or trade NVLS.

Has the stock fallen enough? Shares of memory chip maker Micron Technology (NASDAQ:MU) fell 15% after the company announced earnings for the quarter ending Aug. 31. That came on the heels of a stock that already was down significantly. And there is no guarantee that Novellus will meet even the reduced estimates.

As a guide for how bad things can get for tech stocks like Novellus, I would suggest looking at where the stock traded when things bottomed in late 2008. The stock came very close to hitting $10 per share at that time.

With Novellus trading for 10 times current-year estimated earnings — and those earnings are in decline — the price is too high. The odds suggest Novellus has further to fall in the cycle. The company should offer more clarity Monday, but that dose of reality is likely to be negative. As such, the way to play this one is on the short side, as the stock is likely to lose more value after the report.

As of this writing, Jamie Dlugosch did not own a position in any of the aforementioned stocks.