From Morgan Stanley this morning:
Semiconductors: Sector Update M. Edelstone/L. Gerhardy/J. Cross
--Most of the semi companies will report their C3Q01 earnings results during the weeks of 10/15 and 10/22. Despite the adverse economic impact caused by the terrorist attacks on 9/11, we believe that the number of negative earnings surprises will decline sharply from the levels of nearly 80% and 70% recorded in C1Q01 and C2Q01. More than 50 companies preannounced negative earnings surprises in C1Q and more than 35 preannounced negative in C2Q. While near-term business conditions remain difficult, the number of preannouncements declined to around 15 companies in C3Q, and most of them were third-tier players.
--Due to expected weakness in consumer and IT related spending following 9/11, we hope and expect most of the companies in our universe to provide reduced and cautious C4Q01 guidance, which suggests that the number of negative earnings surprises should return to historically normal levels of 1/4-1/3 of all companies missing expectations in C4Q and throughout C2002. While we have recently lowered earnings estimates on about 1/3 of our companies, including AMCC, AMD, ATML, MU, PMCS, SNDK, STM, TXN, TMTA and XLNX, we expect to lower estimates on most of the remaining companies in our universe except ARMHY, NVDA, and QCOM as C3Q results are posted and we incorporate the impact from the events of 9/11.
--Due to its broad product portfolio and diversified end market exposure, we believe that Motorola (MOT-$17-O-V, covered by A. Shah) can often be used as a proxy for near-term trends in the overall semi, and MOT's C3Q results and outlook were in-line with our expectations. MOT's semi book/bill improved to 1.0, and we believe that most companies will record a Q/Q increase in their C3Q orders and book/bills. MOT expects its semi revenue in C4Q to be flat with C3Q, and we expect the overall semi industry to be flat to slightly up Q/Q. The best growth in C4Q should come from the cellular handset market, while the PC and telecommunications markets should promote the weakest results.
--Due to lower valuations, our belief that industry fundamentals are bottoming, and extremely bearish investor sentiment, we have become more bullish on the semi stocks and believe that investors should be overweight the group. Since 9/10, the average stock in our universe has declined 13%, but the group has advanced by 24% since 10/02. We expect the rally to continue during the next 3-6 months, but believe that near-term profit taking may occur as earnings estimates are lowered to reflect the C4Q01 and C1Q02 impact from 9/11. Our 10 favorite stocks are ARM Holdings (ARMHY-$14-SB-V), Broadcom (BRCM-$27-O-V), Microchip (MCHP-$30-O-V), National Semi. (NSM-$26-O-V), NVIDIA (NVDA-$36-SB-V), Qualcomm (QCOM-$45-SB-V), Silicon Labs (SLAB-$16-SB-V), STMicroelectronics (STM-$27-O), Texas Instruments (TXN-$29-O), and Xilinx (XLNX-$29-O-V).
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