So Much for That Summer Chip Recovery
By Monica Rivituso
February 8, 2001
THE EVIDENCE AGAINST a second-half turnaround in the chip business is piling up with disquieting speed. First the PC makers disclosed evidence of slower sales, then the cellular-phone companies warned of static on the line, and now Cisco Systems (CSCO) is sending bad vibes about telecom equipment.
"We have a major problem to work our way through," warns Dan Niles, a Wall Street Journal All-Star analyst from Lehman Brothers. "And it's going to take a while."
Until Tuesday, when Cisco unleashed its first earnings disappointment in 25 consecutive quarters, chip analysts far and wide had been predicting that the sharp downturn in semiconductor demand that materialized this winter would begin to reverse itself as early as mid-summer. By then, the reasoning went, a glut of chip inventory at the customer level would have worked its way down and economic activity spurred on by the Federal Reserve's interest rate cuts would finally begin to boost demand.
But Cisco's report is changing minds — fast.
Like many other consumers of chips, Cisco began stockpiling components last year in anticipation of demand that never materialized. With economic activity slowing to a crawl in December, fellow telecom-equipment makers Nortel (NT) and Lucent (LU) found themselves in the same position. Wall Street was hoping for an indication on Tuesday that Cisco was making some progress whittling down its supply. Instead, the stockpile grew 29% to $577 million during the company's fiscal second quarter — a far cry from the $200 million some analysts were hoping for. And that can only mean bad things in the short term for suppliers like PMC-Sierra (PMCS) and Applied Micro Circuits (AMCC), both of which have lowered their own earnings guidance in the past few weeks.
Indeed, the latest industry sales data are serving up even more worry. While world-wide chip sales increased by 22% in 2000, they fell 2.1% sequentially in December as customers like Cisco and Lucent worked down those inventories. What's more, the Semiconductor Industry Association says the inventory overhang will prevent world-wide chip sales from meeting its forecast for 22% growth this year.
Says Niles: "Not only do you have to work your way through inventory, but you're in an environment where demand is falling very rapidly."
Cisco management said it would take two or three quarters to work its inventory back down to a level where orders would be needed. And as analysts digested the results, some started talking about whether the worst of the ripple effect may be yet to come. Joe Osha, a Wall Street Journal All-Star from Merrill Lynch, bluntly told clients in a note following Cisco's results: "We have yet to see the brunt of the inventory correction." Likewise, Niles expects that companies like PMC, Applied Micro, Vitesse Semiconductor (VTSS) and Broadcom (BRCM) will all have a difficult time until the fourth quarter. "The fundamentals are getting worse," he says. "So going in there and trying to bottom fish just means you're going to get your hands chopped off."
The telecom chip makers certainly do look tempting — which is why SmartMoney magazine recommended a couple of them in the February issue — well before the Cisco news. Consider PMC-Sierra, which at $58.88 a share is 77% off its 52-week high. In late January it was trading at 110 times 2001 earnings estimates; today it sports a multiple of 69. Ditto for Applied Micro at $46.75 a share. A couple of weeks ago, it had a price-to-earnings ratio of about 92; now it's trading at 59.
And if you've got nerves of steel, there are dissenting opinions on Wall Street. Hans Mosesmann at Prudential Securities remains upbeat about a second-half rebound. He thinks inventories will probably end up being thinned out too much, which will prompt companies to accelerate their chip buying earlier than the bears are saying — maybe by mid-summer. The smart buyers on Wall Street will begin accumulating shares of these stocks before there's any real evidence of inventory improvement, he predicts. So by late spring, we may find "an environment where it's ideal to buy these stocks"
Mosesmann recommends starting to nibble on some of the strong companies now, the ones who are gaining market share, regardless of the end-demand situation. For the long term, Prudential still favors Vitesse, PMC and GlobeSpan (GSPN). "Then when the inventory correction is playing itself out, you can start taking a larger position," he says. "But I wouldn't wait, because the market tends to discount a lot of bad news these days."
If you hold these stocks, another thing to consider is this: While we may have weeks or months to go before the industry bottoms, the long-term outlook for these specialty chip makers remains bright. Calling the bottom is difficult, so you'd be wise to prepare yourself for more jarring news. Remember, though, that when the news improves, analysts generally expect at least another year of growth. Long-term investors would do well to stick with the top-tier names like Xilinx (XLNX) and Texas Instruments (TXN), Mosesmann says. As noted, we like PMC and Broadcom.
"I think that there is going to [continue] to be a build-out of the Internet infrastructure," Mosesmann concludes. "If there's a slowdown in the global economy, then everyone gets impacted. But I think the fundamentals at least with the blue chip names have not changed." That's about the closest thing to an endorsement you'll find these days.
smartmoney.com
So there it is. AMCC is stagnant junk floating on a barge name CSCO, sell it quick before it go to single digits. <gg>
Jack |
