Time To Go Long Semis?

Discussion in 'Trading' started by ARogueTrader, Apr 22, 2004.

  1. Street Patrol
    Why semiconductors are about to surge

    Forget the traditional summertime slump. Prices have fallen enough to bring fundamentals in line, and businesses have lots of aging computers to replace.

    By Robert Walberg

    Semiconductor stocks have lagged the market badly the past few months, as bears’ complaints of overvaluation energized sellers. But the setback may have gone far enough and lasted long enough to allow chipmakers’ valuations to come into line with their stellar earnings growth.

    The stocks now seem poised for a substantial recovery.

    While chip stocks have sunk 14% over the past four months, nothing in the companies’ earnings reports or forward guidance has suggested that business has changed for the worse. The following factors have contributed to the group’s miserable performance:
    Concern that future sales/profit growth will slow from current levels.

    Fear that Nokia’s (NOK, news, msgs) sales warning means trouble ahead for wireless chip companies.

    Belief that seasonal bias will begin to work against the group.

    Worries that valuations are too high.

    Anxiety over the future is understandable, but a slowing in the rate of growth alone is no reason to run from the sector. Maybe Intel (INTC, news, msgs) won’t deliver a second quarter as strong as the first, in which earnings jumped 100% and sales rose 20%. But it shouldn’t have to in order to impress investors.

    Likewise, does Texas Instruments (TXN, news, msgs) really have to post another 200% jump in earnings on a 34% rise in sales for investors to appreciate the simple fact that operations are lean and business conditions are much improved? I don’t think so.

    Fundamentals fall back in line

    No question the semiconductor industry ran ahead of its underlying fundamentals during last year’s impressive advance. However, current results -- witness Motorola’s blowout numbers on Tuesday -- are now justifying the advance, as expectations align more realistically with results.

    If the market’s worries regarding future earnings growth are misguided, then its fear that Nokia’s troubles spell doom for the wireless-chip group is downright laughable. Nokia’s sales shortfall is a problem of its own making and in no way indicates trouble in the handset market. Nokia is simply losing share to the likes of Samsung, Motorola, LG and Sony Ericsson Mobile -- all companies that moved more aggressively into camera phones, the hottest area of growth in the cell phone market.

    Despite Nokia’s woes, most experts expect double-digit growth in handset sales this year, with continued strength in 2005. In other words, the wireless-chip group should be just fine.

    John Rossi, chief financial officer of OmniVision Technologies (OVTI, news, msgs), confirmed as much to me the other day when he noted that business trends for his company remain very strong despite Nokia’s problems. OmniVision makes the CameraChip, an image-sensing device used to capture images in a wide variety of consumer and commercial applications, including digital still cameras, cell phones, video game consoles and security and surveillance cameras. Rossi noted (with some chagrin) that while OmniVision never did much business with Nokia, the overall market for wireless-chip companies remains bullish with exciting growth in the handset segment.

    Just how good has business been at OmniVision? Last quarter, the company delivered earnings growth of 216% on a 209% rise in sales. Despite such impressive growth, the stock hasn’t done much this year. Maybe investors are simply worried that the company’s growth rate will slow to only 150%. After all, the summer doldrums are just around the corner.

    No summertime slump?

    Speaking of the seasonal bias, history supports the notion that the May-to-October period is a good time to underweight the group. However, these are not normal times. Businesses are in the early stages of what is shaping up to be a material computer replacement cycle. In fact, after a strong first quarter, research firm IDC now expects PC sales for 2004 to exceed its early estimate of 13.5% annualized growth.

    Meanwhile, recent earnings reports from the likes of PMC-Sierra (PMCS, news, msgs), Cypress Semiconductor (CY, news, msgs), Advanced Micro Devices (AMD, news, msgs) and Texas Instruments indicate that the communications, wireless and consumer segments of the market also remain strong.

    With the economy continuing to grow at a healthy pace and with most chip companies indicating that the demand outlook remains promising, the traditional summer slowdown is apt to be more modest than normal. Toss in the facts that comparison periods aren’t that strong and that investors have lost interest in the group, and the sector is poised for a sunny summer of besting expectations. Outpacing expectations may not guarantee higher stock prices, but it should alleviate the concern of slowing growth -- and that’s a good start toward reigniting investor interest.

    There was some merit to the argument that valuations were too high very early in the year, when the Philadelphia Semiconductor Index ($SOX.X) was trading near the 560 area and the first-quarter numbers had yet to come in. But the recent slide, combined with the strong profit results, should have alleviated these concerns. Intel, Texas Instruments and OmniVision may all trade at between 22 and 29 times estimated current year earnings, but given strong conditions in PC and handset markets, improved operating efficiencies (which are supporting significant margin gains) and impressive double-digit earnings growth projections, these multiples aren’t outrageous.

    There are exceptions, such as Genesis Microchip (GNSS, news, msgs) and Micron Technology (MU, news, msgs), which trade at 86 and 113 times current estimates. But as you can see from the table below, many chip stocks are trading well off their recent highs and at multiples that are reasonable, if not cheap, given estimated growth.

    With valuations now at reasonable levels and industry demand still strong, look for investors to warm back up to the industry in the weeks and months to come as company after company delivers better than expected top- and bottom-line growth -- even during the traditionally slow summer season.

    5 stocks that should lead

    Which stocks will lead the recovery? Though gains should be broad-based, look for the fast growers and the industry bellwethers to assume leadership. One such stock is OmniVision, which is well-placed to capitalize on the growth in camera phones as well as digital cameras, as it recently introduced a new 2.0-megapixel CMOS image sensor to keep one step ahead of the competition.

    Top chip picks

    Stock % off 52-wk Hi Current earns est. Next yr est. Est. 5-yr growth 4/20/04 price
    OmniVision (OVTI, news, msgs) 22.8% $0.91 $1.42 20% $25.50
    Texas Instruments (TXN, news, msgs) 18.2% $1.04 $1.38 20% $27.35
    Intel (INTC, news, msgs) 23.5% $1.20 $1.43 15% $26.07
    Analog Devices (ADI, news, msgs) 10.8% $1.46 $1.99 20% $45.95
    Taiwan Semiconductor (TSM, news, msgs) 19.2% $0.56 $0.71 28% $10.25

    Texas Instruments and Intel should also pace any recovery as margins are expanding, sales are relatively strong and the stocks are reasonably priced.

    I also like Taiwan Semiconductor (TSM, news, msgs) and Analog Devices (ADI, news, msgs). The former will benefit from the computer-replacement cycle and discounted valuations, while the latter’s diversified product lines, solid financials and better-than-sector growth prospects leave it well-positioned for renewed gains.

    If you can discount the noise and focus on the facts, the outlook for the chip sector looks pretty good. As a result, investors should take advantage of any near-term weakness to load up on the group in preparation for a strong second half. I’ll report back on the group and the stocks in the months to come.

    At the time of publication, Robert Walberg did not own or control shares of any of the equities mentioned in this column.
  2. vinigar


    Jim Cramer would have to agree with this view. On his radio show he has stated he bought Intel just the other day. He also says that this sound fundamental company and techs in general should do well in the up and coming market climate. At this time Intel has formed a double bottom. A reversal pattern is in place. MSFT a heavy weight is way up in the after market...should be a short squeeze and a wave ride tomorrow. We will see.
  3. Interesting, umm, "analysis". Basically his argument seems to be that since the stocks are down and business, according to him, is good, the stocks should go up. Uh, okay, if he says so. But what about valuations? What about the moderating business cycle? What about Intel and KLAC's disappointing guidance? What about the channel/inventory issues? What about the more difficult comps and less favorable currency translations going forward? What about possible overheating in China, which has been the main engine for growth the past several quarters? What about. . . .

    Look, I know the space often trades without regard to fundamentals. But at least the sell-side cheerleaders get creative in coming up with monetized eyeballish justifications for unjustifiable multiples. This guy didn't even do that. Hence, if nothing else, I give him an "F" for lack of imagination.
  4. vinigar


    Strange how we can find hundreds of cases every day where stocks perform either poorly or just plain great. Regardless of fundamentals. That is the the stock market. Sad but true. You know as well as I do, just about any thing can move the market on a moments notice. Could be greed, could be news, could be panic....who knows. Sometimes valuation and fundamentals just don't do anything for a stock and other times yes they do. Beauty is in the eye of the beholder....and if it looks good to them...they are going to buy it just like did, regardless of anything else.
  5. Very true, and I have no opinion either way on the validity of the article's conclusion -- that the semis are due for a rally. Rather, I was merely commenting on the utter dearth of analysis in the ostensibly analytical article that ART posted for us. It quite simply failed to make the bull case, which may or may not otherwise have merit.
  6. vinigar



    Yep, I agree with you bud...maybe he should have payed more attention in English class. You know....supporting what you are stating with some facts and references.:D
  7. There you go. And I just saw your planned INTC trade. Good luck with it. I'll be hoping the article proves prescient for you, notwithstanding the criticism.
  8. There are more than just a few large brokers out there that have downgraded the group based on revenue growth peaking during the June quarter. Data points suggest that March order rates were driven by inventory replenishment in selected markets and this is what is making people cautious on the sector.
  9. Large Brokerage firms have a history of downgrading in order to accumulate inventory at discounted prices.

  10. Ahh, always the conspiratorialist, huh ART? Hey, now that you mention it, wasn't that Jack Grubman behind the grassy knoll?
    #10     Apr 23, 2004