Sector Move - Semiconductors Downgraded: Briefing.com is lowering its rating on the semiconductor industry from 4 Stars (slightly outperform) to 3 Stars (perform in line with the S&P 500). Since raising the rating on August 20, the sector, as measured by the SOX index, has matched the S&P 500 index. Yet, it has made a very good run in recent weeks and the Applied Materials (AMAT 15.82 -0.63) news this morning underscores the long-term problems in the industry.
The semiconductor industry, and the equipment makers especially, are extremely sensitive to demand. The stocks have always been a play on an economic recovery. Briefing.com forecasts decent economic growth this quarter and next year. This cycle, however, may not produce the typical leverage for this industry. Business investment will remain relatively weak in this recovery. Demand for chips will not rebound as it usually does. Overcapacity and price pressures won't fade as quickly as they have in past recoveries.
As a Lehman Brothers research note this morning stated, another problem is that the stock prices have factored in a strong rebound in demand even while the fundamentals at these companies remain horrible. The recent run in the SOX index and the high valuations offset our forecasts of decent economic growth the next few quarters, and leave our opinion on the sector as mixed - or neutral.
Consider AMAT. They announced significant layoffs yesterday. That reflects expectations of depressed demand over the longer term. Revenues in the third quarter (Jul) were up 46% from the first quarter, but revenues are still only 50% of the peak reached in the fourth (Oct) quarter of 2000. Even if revenues rise 50% from here, they will still be 25% off their peak. And if AMAT is laying 11% of their workforce, it is doubtful they see another 50% rebound in revenue anytime soon.
AMAT made $0.15 on a per share operating basis the past four quarters. That produces a 12-month trailing price/earnings (p/e) ratio of 106. Their most recent quarter was $0.07 operating profit per share, which annualizes to $0.28 produces a p/e of 57. For the fiscal year that just started Nov. 1, the consensus estimate is for AMAT to earn $0.39 a share. Even that produces a p/e of 41. It's pretty obvious that the stock is already priced for solid earnings growth.
Briefing.com isn't bearish on either AMAT or the semiconductor industry overall. We're just going neutral given the extremely high valuations and the continuing lack of any clear long-term growth in demand. The argument that semiconductor stocks and the equipment makers are the first cyclical stocks to move, has some merit. But some of that move has been made, and in this cycle, weak business investment may keep the SOX as just an average performer. The rating change will be made on our Sector Ratings page later today. Dick Green, Briefing.com |
