SMARTMONEY.COM: Chips Are Yum-Yum Good
By MONICA RIVITUSO
NEW YORK -- Chips get a lot of attention.
Take your basic potato chip - there's plain, ridged, kettle-cooked, baked, salt and vinegar, sour cream and onion, not to mention cheddar cheese and barbeque. Then there's a flavorful array of corn chips and tortilla chips. And that's just one side of the convenience store snack aisle.
But as passionate as people are about snack chips, there's another kind of chips that evoke even more feeling: semiconductors. Seriously. These tiny chips - slightly harder than a typical dipping chip - have been solid moneymakers lately. And given this sector's strength, the urge to eat, er, buy more is pretty compelling.
Ever since the semiconductor sector started to swagger back from a three-year downturn last year, the good news has been plentiful. Business is solid, and, as expected, chip companies fared quite well in their most recent quarterly earnings reports. Now, industry growth forecasts are once again cranking up. The majority of these stocks have had terrific runs. So, the question in this environment is, what's a chip fan to do now? Push away the bag? Probably not. But to invest in chips these days, it's important to know where the best growth is and where the experts see opportunity. And it's important to know when to stop eating.
First, let's look at where chip stocks are currently sitting. By now, the semiconductor upturn is nothing new - the secret is long out. Consider that the Philadelphia Semiconductor Index, commonly referred to as the Sox, surged 100.1% last year. This year, the much-watched chip index jumped another 89% by March 10. But like other technology sectors, it went too far, too fast, and when tech started to head south, chip stocks slid too. Still, as of Friday's close, the SOX stood 34.8% higher this year.
Semiconductor stock enthusiasm isn't unmerited - there are some pretty solid fundamentals supporting these businesses. Indeed, chip companies have had some of the strongest revenue and earnings growth around, and many of the recent quarterly reports beat consensus expectations. On the heels of these strong results, market research firms are once again upping their forecasts.
"The semiconductor market as a whole, its strength has surprised people," says Joseph Byrne, an analyst at Gartner's Dataquest.
Dataquest now predicts total world-wide semiconductor sales will increase around 31% this year and 27% next year. As for 2002, revenue growth should slow to the mid teens. "So, 2002 is the beginning of the end," says Byrne.
Likewise, IC Insights, the Scottsdale, Ariz.-based semiconductor market research firm, is also hiking its chip forecast. It now sees the industry growing 32% this year, up from its previous forecast of 23%. Next year, IC Insights is calling for 25% to 30% growth in world-wide semiconductor sales, but then sees the sector slowing to 10% growth or less in 2002. The firm figures the slowdown will last through 2003 before things start picking up again in 2004.
For now, however, the chip market has never looked better. IC Insights President Bill McClean says a number of factors, including capacity constraints, component shortages and surging demand for PCs, cell phones and video games, will come together to foster a super-charged semiconductor market in the second half of this year. "Everything is setting up for a classic boom time in the semiconductor market," he says.
So, fine. The industry is booming. But is the good news already priced into these stocks? "I think it has been for a long time now," says SG Cowen analyst Drew Peck.
Peck's not known as one of the Street's carefree bulls. But he's not standing out there alone, either. Two weeks ago Josephthal & Co. analyst Lawrence Borgman lowered his ratings on Intel (INTC), Advanced Micro Devices (AMD), Teradyne (TER), Altera (ALTR) and Pericom Semiconductor (PSEM) to Hold from Buy. In a note to investors, Borgman explained that these stocks had either reached his target prices or were trading at historically high multiples.
And after the Semiconductor Industry Association (SIA) released its March sales data showing world-wide chip sales had reached an all-time high of $14.96 billion, Cahners In-Stat Group analyst Grant Johnson sounded a cautionary note in one of his reports. "The good news is that the SIA data reflects the strongest chip performance in the last 10 years," he wrote. "The bad news is that the market already discounted all of this good news months ago."
There's another wrinkle to the chip picture, namely the Federal Reserve. A change in economic outlook could alter perceptions about just about anything, and with chips, the amount of inventory building could become a worry point, according to SG Cowen's Peck. In 1998 during the Asian financial crisis, what was previously viewed as appropriate inventory levels were suddenly perceived as too high. Needless to say, sales slowed. While it's difficult to predict what macro shift in sentiment could rattle chip stocks, Peck says he's concerned that interest-rate hikes are being treated with a certain amount of "aplomb."
And that's why Peck's really getting selective in his stock picks. With so much already baked into many of these names, it makes sense to identify the high growth areas in the chip market, as well as what the best plays are now. "I'm talking about being defensive in an environment where everyone is rampantly optimistic," he says.
Right now, Peck likes several "compelling" momentum plays, like SDL (SDLI), which specializes in integrating lasers with chips; GlobeSpan (GSPN), which makes chips for digital subscriber lines; and Applied Micro Circuits (AMCC), which manufactures high-bandwidth chips. There's a reason these are called momentum plays - they are trading at some pretty lofty valuations. But Peck says he sees steady performance in these stocks, primarily because the companies should continue to deliver earnings surprises.
Other chip names Peck recommends that look "grossly" undervalued include Cypress Semiconductor (CY), which focuses on chips for networking and communications products. The stock trades at 25 times this year's First Call/Thomson Financial consensus estimate of $1.97. Another is Burr-Brown (BBRC), which also focuses on the communications market, but trades at a richer P/E of 44.7.
Flash memory - the kind that retains data when power is switched off - is another particularly hot semiconductor area. These types of chips are in high demand now, as they're packed into such products as cell phones, television set-top boxes and digital cameras. Companies that make flash memory include Intel, Atmel (ATML) and Advanced Micro Devices.
In particular, Advanced Micro Devices - which is trading at 16.9 times the First Call/Thomson Financial consensus earnings estimate of $5.11 - is considered a bargain by several industry watchers. On Thursday, Gerard Klauer Mattison & Co. analyst Jack Geraghty upped his 2000 and 2001 earnings estimates and raised his price target by $20 to $120. Citing higher shipments of its high-end Athlon chip and strong flash memory sales (expected to reach $1.55 billion or 31% of AMD's total sales this year), Geraghty called the price of AMD shares "compelling," despite their nearly 200% climb since the beginning of the year. However, investors should keep an eye on this company's manufacturing ability, traditionally its greatest weakness. For now, analysts say, so far so good.
Programmable logic devices (PLDs) are another robust chip area. As the name suggests, these chips have logic integrated into them and can be programmed to perform a variety of tasks. Altera and Xilinx (XLNX) both make these chips, which are found in all types of communications devices and equipment. Business is strong and these stocks reflect it: Altera and Xilinx shares are trading at 48.2 times and 56.7 times respective earnings estimates.
Robertson Stephens suggests LSI Logic (LSI) might be a better way to profit from the fast-growing communications market now. Wall Street Journal All-Star Dan Niles reminded investors this week that LSI's broadband and networking products are driving revenue. And trading at 30 times his 2001 earnings estimate, the stock remains "one of the cheapest ways to play the communications (chip) market," according to Niles.
While there are distinct product areas that should grow faster than others, there are also geographic pockets poised to pop. To see some real chip muscle being flexed, watch the Asia-Pacific region, Japan and Europe. Chip sales in the Americas should increase 25% this year, according to IC Insights - not too shabby. But that pales in comparison to expected sales increases of 41% in the Asia-Pacific region, 30% in Japan and 36% in Europe. Bottom line, says IC Insights' McClean: the more exposure to Asia-Pacific, the better.
So, while semiconductor stocks have had solid runs, there could be more gains to come. The challenge now is picking the chips that aren't stale. By playing it smart, experts say, investors should be able to nibble on these tasty treats a good while longer.
For more information and analysis of companies and mutual funds, visit SmartMoney.com at smartmoney.com
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Starting to see the dripping of negativity toward the sector.
Jack |
