Gaping Holes in the SOX Recovery Story
By Herb Greenberg
Senior Columnist
01/03/2003 10:06 AM EST
URL: thestreet.com
Say this for Tom Kurlak: He's persistent.
Yesterday he posted another column on why chip stocks are undervalued. Though I don't know Kurlak, I respect him based on his reputation.
What I don't understand is his talk about stronger demand. In reality, information technology managers are talking about lower budgets this year -- not higher ones. And the economy certainly isn't showing any strong signs of improvement.
Let's take a look at some assertions Kurlak makes in Thursday's piece on RealMoney.com. Then we'll get a point-by-point reaction from my best chip source -- who I think is every bit as good as Kurlak in analyzing the industry and who is short as many chip stocks as Kurlak is long. The source, a hedge-fund manager who isn't allowed to speak on the record, presents an argument that makes the bullish case on this sector seem a lot less compelling.
Kurlak: "Evidence of improving industry sales is emerging, thanks to strengthening end demand, particularly in cell phones and personal computers, which together account for nearly half of total semiconductor consumption."
Chip source: "Cell phone and PC demand was by any account outright weak this holiday season. Every wireless service provider has disappointing net adds. People needed to give phones away to sell them. PC demand and retail demand overall stunk -- this was the worst Christmas in the last 10 years, period. Nokia's (NOK:NYSE - news - commentary) mid-Q update was a huge disappointment to people.
As Kurlak said, "cell phones and PCs account for 50% of semiconductor demand. Given demand there is actually so weak, we are in for more trouble."
Kurlak: "There's just no slack in the supply chain between factory and customer. One large chip distributor, Avnet (AVT:NYSE - news - commentary) , reports having the lowest inventory-to-sales ratio in its history."
Chip source: "Inventory-to-sales level at Avnet is so low because they are having a liquidity crisis, because end demand is so weak they are trying to lower inventory to generate cash. Also, Avnet expects Q1 sales to be very weak and is lowering inventory so they have the proper amount on a forward basis. Less inventory for lower sales."
Kurlak: "The Semiconductor Industry Association has now reported three straight months of 20% year-over-year sales growth without any help yet from chip pricing."
Chip source: "These statistics were viewed by most analysts as universally disappointing. This was a distinct slowdown from previous months' growth rates, and marked a top in the current cycle. The only reason it was up 20% year over year was because of easy compares against last year's disastrous inventory bubble. Sequentially, the industry is showing no growth in what should have been a seasonally strong period."
Kurlak: "Wall Street received some confirmation of better demand when, in early December, several leading semiconductor companies, including Intel (INTC:Nasdaq - news - commentary) , Texas Instruments (TXN:NYSE - news - commentary) and Xilinx (XLNX:Nasdaq - news - commentary) , raised their forecasts for December-quarter sales -- the first such upward revisions in more than a year. National Semiconductor (NSM:NYSE - news - commentary) also reported stronger-than-expected fiscal second-quarter sales. In addition, gross margins are starting to improve (a good leading indicator), which also reflects pricing stabilization as well as cost reductions."
Chip source: "He fails to mention Silicon Storage (SSTI:Nasdaq - news - commentary) , Integrated Device Technology (IDTI:Nasdaq - news - commentary) , Cypress Semiconductor (CY:NYSE - news - commentary) and Cirrus (CRUS:Nasdaq - news - commentary) preannouncements of weaker-than-expected results.
"Xilinx raised guidance by a whopping 1%. National Semiconductor beat this quarter, but then gave weaker-than-expected guidance for the upcoming quarter and the stock sold off. Intel also sold off after their mid-Q update."
Kurlak: "It's looking increasingly likely that first-quarter sales will increase sequentially from the fourth quarter rather than decline slightly, as would be seasonally normal."
Chip source: "Giant contract manufacturers that produce everything electronic like Jabil (JBL:NYSE - news - commentary) , Solectron (SLR:NYSE - news - commentary) and Flextronix (FLEX:Nasdaq - news - commentary) guiding Q1 down 5% to 10% on an organic basis? Where is this growth going to come from if end-markets are all down?
"Here is a blurb last week from Jon Joseph, the semiconductor analyst at Salomon Smith Barney:
"'We believe most companies will guide Q1 revenues 'flat to down 5%' in coming weeks, though 'lack of visibility' and a weak December could make for a cautious tone on the calls.' "
So much for that. Keep in mind too that Kurlak's original call from Oct. 31 had a time horizon of three to five years to make "three to five times" your money. Contrary to the tone of his latest column, that analysis didn't appear to be geared for a quick trade. Good thing, too, because his top picks from that column -- Nokia, Applied Materials (AMAT:Nasdaq - news - commentary) and Intel -- were down an average of 11% from the day of his call through year-end.
Even with Kurlak's five-year outlook, there is no rule that says chip demand won't simply muddle along in fits and starts for that long -- or even longer. After all, last time I looked, there wasn't any new Internet-like boom waiting to drive demand to old levels. Which brings us to my source's targets for Kurlak's favorites:
Applied Materials: $5. "It should trade at a price/earnings multiple in line with other little-growth cyclicals like paper and chemicals," the chip source says. "Applied will not grow in this cycle."
Nokia: $10. Contrary to what the numbers show, "They are losing market share to Chinese and other low-cost manufacturers. Their margin structure is also unsustainable."
Intel: $10. "No growth in PCs. There's no demand for more processing power. My PC runs Microsoft Word just fine with a 3-year-old Pentium, thank you very much."
So does mine!
I respect Herb for his track record. I wince when I see a target of AMAT at $5 though.
Jack |
