Semiconductor Sector Poised for a Rebound
Friday June 02, 2000 (4:55 pm ET)
By Thomas W. Smith, CFA, S&P Equity Analyst
NEW YORK, Jun. 02 (Standard & Poor's) - If industry fundamentals are so great, why have chip stocks suffered lately? Surely many investors moaned this complaint this spring, as rising interest rates sent a shudder through the whole stock market, affecting even the high-flying semiconductor sector.
Through April 7, performance was looking pretty good for the semiconductor and semiconductor equipment sectors tracked by Standard & Poor's, with year-to-date gains of 65.0% and 73.3%, respectively. Even the component distributors sector was up a tidy 18.1%, compared with a 3.8% gain in the S&P Super 1500 Index.
But just a week later, the year-to-date gains for the semiconductor sector was cut to 28.1%, while the semiconductor equipment sector y-t-d gain dropped to 21.1%. The component distributors' y-t-d gain was cut to 1.4%, which looked good relative to the Super 1500's loss of 7.3%.
The sector indices continued to bounce up and down through April and May. By May 26, chips had a y-t-d gain of 35.8% and the equipment makers were up just 10.4%. Sure, it's nice to have a positive return, but ouch! To be up just 10% after being up over 70% hurts.
Happily for bulls, tech stocks have enjoyed a comeback week and the chip stocks are a big part of it. I believe the chips stocks surpass their former highs this year, for several reasons.
First, fundamentals for the industry remain terrific. Second, earnings estimates are being adjusted higher as analysts continue to see very strong booking trends at almost all chip companies. Third, the chip companies, despite being subject to cyclical swings, tend to have more substantial and visible earnings flows than do many companies in more speculative areas of the technology sector, such as Internet companies that are priced on a price-to-revenue basis.
Fundamentals are still great
As the stock market swooned this spring, chip sales were accelerating. On June 2, the Semiconductor Industry Association (SIA) reported that worldwide sales of semiconductors hit a record level of $15.2 billion in April 2000, up 35.6% from the prior year period. Product segments doing especially well included flash memory chips, digital signal processors, and programmable logic chips. Sales of flash memory were up 193% in the first four months of 2000, compared to the prior year period. These chips are used in wireless phones, cars and home appliances. Communications segments continue to supplant computer segments as the hot growth area, even as sales of DRAM and many other computer-related chips remain robust, with growth above 30%, year over year.
On May 30, the World Semiconductor Trade Statistics (WSTS) group, SIA's statistical branch, raised its forecast for global semiconductor sales in 2000 to 31%. While this fits in with the sales trends seen in the first four months of 2000, it is remarkably higher than the 20% growth estimated in SIA's November 1999 forecast. The WSTS expects chip sales to increase through 2003, although it expects the rate of growth to slow by then, as fabs under construction now come on line in sufficient numbers to reduce chip prices.
Business is booming for the equipment suppliers, too. The book-to-bill ratio for April 2000, reported by Semiconductor Equipment and Materials International (SEMI), came in very strong at 1.42, indicating $142 of orders flowing in for every $100 of goods shipped. Bookings were 94% higher than year-ago levels. While the April level was slightly lower than the 1.46 book-to-bill (revised) for March 2000, it confirms that there is a huge flow of orders for equipment to expand capacity at existing wafer fabrication plants, as well as to build a new generation of fabs. Equipment suppliers are reporting substantial "technology buys," to modernize customers' operations, as well as "capacity buys," to simply add production capability.
In interpreting a book-to-bill ratio, a ratio above 1.0 means the industry is expanding. Ratios above 1.2 imply a rather strong expansion. Numbers above 1.4 imply a mind-bogglingly rapid expansion. Numbers above 1.4 are unlikely to be sustained for long, yet we have essentially been there since January 2000 when the book-to-bill jumped to 1.39 (Feb. 1.44, Mar. 1.46, April 1.42). We expect the pace to slacken in the second half of 2000, but anything in the range of 1.1 to 1.3 still implies a healthy, growing equipment market.
Chips we like
Many chip companies now offer compelling valuations. For instance, based on the closing prices for June 1, Taiwan Semiconductor Mfg ADS (TSM; S&P STARS ranking , buy), the world's largest chip foundry, has a PE to growth ratio (PEG) of about 1.2. (TSM's price of 36.6 divided by our $1.01 EPS estimate for 2001, creates a PE ratio of 36. Dividing the 36 PE by analysts' estimated long-term growth rate of 31%, creates a PEG of 1.2). So, here you have an opportunity to buy a company growing at 31% for a PEG of 1.2. In comparison, the PEG on the S&P 500 is higher at 1.7 and the growth lower (assuming PE 22 on 2001 est., growth 13%). We believe TSM has an excellent chance to outperform the broader market over the next six months, given its expected faster growth and its cheaper relative valuation on a PEG basis.
Other chipmakers with PEG ratios below the broader market's PEG include Microchip Technology (MCHP; ) and LSI Logic (LSI; ). Another stock we like, Analog Devices (ADI; ), has a PEG of 1.7, which is in line with the market PEG level, but the company is growing earnings about twice as fast as the broader market.
Two more of our top picks among chipmakers sport PEGs above the market, but they have particularly consistent, high-margin businesses that should merit a premium: Xilinx Inc (XLNX; ) and Maxim Integrated Products (MXIM; ). All our 5-STAR chip makers have long-term growth rates above 20%. The table below may make the comparisons more readily apparent.
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This news of continued expansion is welcome news indeeed.
Jack |
