<..Which is why I'm on the sidelines ...>
Pretty quiet here Meghan.
ADI up today on Peck's comments:
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Chip Companies -2: Some See Telecom As Safe Haven
In this tough PC pricing environment, many Wall Street analysts are suggesting that investors look to chip companies catering to the telecommunications industry. By and large, telecommunications was a strong sector for chip makers in 1997, although the fourth quarter will snag the trend of year-long growth for some.
While Asia's problems could affect cellular-phone demand, chip sales to networking companies should be all right, said Cowen & Co. analyst Drew Peck. He's recommending analog chipmakers such as Analog Devices Inc. (ADI), which makes digital-signal processors, or DSPs.
"You don't want to stick your neck out too far with companies with exposure to the PC business or Asia," Peck said. "That leaves you with generally strong telecommunications companies and data networking, and a good way to play that has been analog and DSP chipmakers."
He expects Analog Devices, of Norwood, Mass., to earn 29 cents a share in its first quarter ending in January, compared with 23 cents a year earlier.
The largest DSP manufacturer, Texas Instruments Inc. (TXN) of Dallas, is seen posting earnings of 60 cents a share in the fourth quarter, compared with 25 cents a year ago, excluding special charges and after a 2-for-1 stock split paid Nov. 21, according to First Call.
But Peck said TI's exposure to the dynamic random-access memory, or DRAM, chip market merits caution. The commodity-like DRAM chip prices have fallen through the floor, and analysts hesitate to say whether they have bottomed out.
Xilinx Inc. (XLNX), which makes programmable logic chips used in telecommunications and data networking, is seen earning 39 cents a share in the December quarter, compared with 33 cents a year ago.
While many chip stocks have been pounded in the wake of Asia's economic crisis, the chip-equipment sector has been hit hardest. Investors fear that Japanese and South Korean chip manufacturers will cut back on spending for new equipment, hurting American suppliers like Applied Materials Inc. (AMAT).
"The stage has been set for a pretty brutal reporting season," said PaineWebber Inc. analyst Gunnar Miller, noting that bad news already has come from equipment makers Kulicke & Soffa Industries Inc. (KLIC) and FSI International Inc. (FSII).
Applied Materials, which reports Feb. 9, is expected to earn 50 cents a share in its first quarter ending in January, compared with 24 cents, excluding items and after a 2-for-1 stock split paid Oct. 14, a year earlier, according to First Call.
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And back on the 23rd, SmartMoney picked ADI with the following comments:
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Semiconductors
First Choice: Analog Devices (NYSE: ADI, $31.31)
Runner-Up: Lattice Semiconductor (Nasdaq: LSCC, $56.09)
You may be surprised to find semiconductor makers among our favorite sectors. No, it's not that we think the well-publicized overcapacity problems of memory-chip makers like Texas Instruments and Micron Technology will go away anytime soon. In fact, we'd bet that the continued construction of chipmaking facilities and a fall in Asian demand will make this another forgettable year for memory chips.
But we view all that as an opportunity. Because the important thing is, all chipmakers are not alike. While overproduction and weak demand from PC makers will certainly affect some classes of chips, it won't hurt all of them. And as long as money managers dump any stock with the word "semiconductor" in its name, you'll have frequent opportunities.
Take Analog Devices. It trades at 22 times fiscal 1998 earnings, but the fiscal year started in November and includes an expected soft winter quarter. For calendar 1998 the P/E is a much more reasonable 18.3. Not bad for one of the leading suppliers of standard linear integrated circuits, a high- margin business. SLICs are semiconductor chips that take analog data -- things like voltage and wireless signals -- and manipulate them electronically.
This Norwood, Mass., midcap is the leading maker of two important types of SLICs: amplifier chips and data converter chips. In 1996 Analog became the leading amplifier maker, surpassing National Semiconductor, while its 27 percent share of data converters is twice that of its nearest competitor, Texas Instruments. The converter function is central to any product that takes sounds or images and processes them digitally, such as digital cameras or the latest generation of cellular phones. Worldwide sales of digital cell phones are expected to increase to 230 million, from 60 million, by the year 2001, according to Dataquest.
SLIC manufacturers have several advantages over other semiconductor makers. For one thing, the chips do not require leading-edge manufacturing technology. That leads to lower costs and higher margins, typically over 50 percent gross and 25 percent pretax. The product cycles are much slower: Analog Devices, for instance, still gets 40 percent of its SLIC revenue from products introduced before 1988. Yet in spite of the manufacturing advantages and high margins, leading analog-chip makers face little new competition. That's because the number of engineers capable of designing linear circuits is limited. It takes a decade of on-the-job training to get good at it. "Linear engineers are weird. They don't teach this stuff in school," says David Wu, technology analyst at ABN Chicago.
Analog Devices' strong position in linear products does not mean it has ignored digital engineering and digital chip design. About one-quarter of its revenue comes from digital signal processors, chips that perform intensive computations on digital signals. Combined with analog chips like data converters, DSPs are the guts of wireless communications equipment, imaging applications and sophisticated electronic military devices. Led mainly by the cellular-communications revolution, demand for DSPs is expected to grow from $2.2 billion in 1996 to $6.7 billion in 2000.
Analyst Drew Peck of Cowan & Co. points out that if Analog Devices, with $1.2 billion in total 1997 revenue, just keeps its 11 percent share of the DSP market, that will mean almost $500 million in sales growth for that product line alone. And the firm may do better than that. In 1995 it had only 7 percent of the DSP market, but has since pushed Motorola aside to become the third-largest player.
Last year was not a great year for Analog Devices, which helps explain why its shares are a good value now. Sales rose only 5 percent, in part because the company announced a new product line for cellular phones. Big purchasers such as Phillips and Siemens drew down their existing inventory of older chip sets, while awaiting the start of production on the new designs. Those should start to roll out early this year. Peck, who expects sales to grow 30 percent, is among several analysts with a target price for 1998 of $40 or more a share.
Our runner-up, Lattice, is in another low-profile, high- growth segment of the semiconductor business.
Wall Street analysts expect the earnings of this Hillsboro, Ore., manufacturer to grow at an annual average rate of 26 percent over the next three to five years, yet the company trades for a mere 18.3 times next year's earnings. (Its current fiscal year ends in March.) The stock became even more of a value as we went to press, getting hammered when competitor Altera released disappointing earnings.
Lattice makes chips called programmable logic devices, one of the hottest technologies around. The $2.3 billion market for PLDs is expected to grow by 30 percent a year, according to Morgan Stanley estimates. And Lattice's version of PLDs is the hottest of the hot. Why? Largely because of its unique flexibility when it comes to programming. With its chips, "customers like Cisco, 3Com and AT&T can reduce their design times and get their products to market more quickly," says analyst Richard Owens of Jensen Securities.
This corner of the semiconductor market is growing anywhere from 75 to 100 percent a year, depending on which analyst you ask. The company isn't without rivals, of course. Altera and Xilinx are getting into its subsection of the chip business. But Lattice CFO Stephen Skaggs confidently boasts his company is two years ahead of those two. CIBC Oppenheimer analyst Ken Pearlman agrees with him, citing Lattice's much broader "suite of tools and products."
Some investors may be rightly concerned that 27 percent of revenue comes from Asia. However, not all of the final customers are Asian. Some of those sales are to customers who assemble PLDs into electronics that are then shipped back to the U.S. and Europe. Plus, since Lattice buys the silicon wafers for its chips from Japan and Taiwan, any currency depreciations may actually end up lowering its costs.
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Steve
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