To all, FYI, find S3....
Outlook Is Unchanged
By Charles Boucher
Fourth-quarter 1996 earnings reports confirm continued recovery in the semiconductor industry, but also highlight the divergence in profitability between proprietary and commodity device suppliers.We have argued since the semiconductor stocks bottomed in the summer that orders and revenue bottomed in the July time frame, and should demonstrate relatively strong growth from that bottom. We have also argued that the strength in the recovery would be product-dependent, due to the continuing capacity overhang in the industry,and that earnings growth in general would not mirror order and revenue growth due to price erosion and low-capacity utilization rates. We believe this viewpoint was validated by the latest earnings reports.Unit demand for semiconductor products underwent a robust recovery during
the December quarter and dollar bookings have followed, since the magnitude of price decreases has slowed considerably. In our opinion, the strength of the recovery was somewhat overstated due to the very deep trough that was set during the summer as OEMs worked off component inventories down to unsustainably low levels, and as expectations for a strong December quarter led to aggressive PC production ramps.Investor reaction to this recovery led to surging stock valuations that, in some cases, exceeded levels consistent with the earnings potential of the companies during the next 12 to 18 months. These expectations were reset during the fourth-quarter earnings reports.Our outlook for the semiconductor market has not changed within the last six months. We expect to see continued growth in semiconductor unit and dollar consumption by the PC, server, workstation, peripheral, telecom,datacom, automotive, industrial, and consumer application markets in 1997. Demand is healthy and should remain so.We also expect that excess wafer capacity is likely to cause a stratification of financial performance, favoring the differentiated product suppliers and penalizing commodity product manufacturers. Overall industry earnings strength in 1997 is unlikely to be close to 1995 levels, even as total revenue meets or exceeds 1995 revenue levels, due to gross-margin pressure from price declines and underutilized capacity.We believe the semiconductor industry is an
excellent long-term investment opportunity. In broad terms, we think the technology market will continue to grow as a percentage of the
gross domestic product, and should outperform the broad market in
terms of revenue and earnings growth.
However, investors must recognize that the semiconductor business is
cyclical, and the industry expansion that occurred from 1991 to 1995 was something of an anomaly.Although we have seen the bottom of the
correction, we think that only very well-positioned companies in
markets with substantial barriers tocompetition are likely to exceed 1995 earnings levels in 1997. These include companies such as Altera, ESS Technology, Intel, Lattice, S3, 3DLabs, Trident, and Xilinx. Many of these companies are fabless, which is an advantage in an environment of underutilized capacity.Companies with exposure to commodity products such as DRAMs and SRAMs,or with significant underutilized capacity, are likely to experience continued margin pressure and generate earnings in 1997 significantly below peak
1995 earnings levels. These include companies such as Cypress Semiconductor, Integrated Device Technology, Micron, and Texas
Instruments.We continue to recommend a selective investment strategy,
and would advise investors to shift holdings from commodity semiconductor companies into differentiated product companies. Only investors with time horizons in excess of 12 months should look at commodity chip stockstoday.
-Charles Boucher is a semiconductor analyst with UBS Securities in
SanFrancisco.
Copyright (c) 1997 CMP Media Inc.
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