Great article on PMCS - smartmoney
I just started following this stock so my knowledge is limited.
PMCS is CISCO's main chip supplier and CISCO's inventories were up this quarter. Therefore, some folks think that CISCO will order less stuff from PMCS this quarter. That is the main reason I think the price fell.
There is a great article at smartmoney.com
on PMCS ridding CISCO's coat talls.
Here is a portion of the artcle from Smartmoney.
"We want to be boringly consistent," said CEO John Chambers in a recent interview in The Wall Street Journal, and even bankers on the telecom equipment side, where Cisco is not yet considered a major player, stand in awe of Cisco's solid track record. "This company's as predictable as it gets," says Tim Kellis of Adams Harkness & Hill, who tracks Lucent and other communications companies.
You would think that Cisco's stellar "boring consistency" would rub off on some of the companies that supply the network giant with parts for its routers and switches. So far that has not been the case. But as Cisco extends its dominance in the networking universe, there are compelling reasons to believe that a halo effect may reach Cisco's suppliers just as it has many of the companies that do business with Microsoft.
We came up with an informal list of nine technology companies whose products and services Cisco depends upon. Hardly any have benefited from their ties to Cisco yet. And many have company-specific issues unrelated to doing business with Cisco that have depressed their stock prices of late. But one company seems to be uniquely tied in with Cisco's success as a manufacturer. In fact, it's fair to say PMC-Sierra (PMCS) goes beyond the call of duty in supporting Cisco's boringness.
PMC makes a variety of so-called physical-layer semiconductor chips for Cisco's high-end ATM gear, the kind Cisco is selling to the telcos of the world to build out telephone-grade Internet Protocol (IP) networks. And with the acquisition of privately held Integrated Telecom Technologies during the quarter, the company is moving into the kinds of sophisticated network-switching silicon that has made MMC Networks (MMCN) a highflier on Wall Street.
Fact is, PMC is leading the way in helping Cisco develop many of the key technologies of networking for the next few years. "I consider them an Intel or Cisco in their area," says communications chip analyst Sandy Harrison with Pacific Growth Equities in San Francisco.
But PMC's thanks for taking the lead was something of a negative bounce yesterday. Shares of PMC dropped more than 12% after analyst Clark Westmont with Montgomery Securities said the company can look forward to seasonally slowing growth in the September quarter. That's after falling $7 back on July 17, when, after beating the Street's earnings estimate by a penny, PCM announced that R&D would increase in the coming year, offsetting profit growth in networking. At Thursday's close of 32 5/8, the stock is down from Wednesday and trading at less than half of its 52-week high of 50.
Analysts say PMC may have been a bit overbought at 50, a 47 times multiple of last year's earnings. And there are some issues specific to the company that have made PMC a less than boringly consistent issue. And the R&D increase, from 17% of revenue to 22% or 24% going forward, is only one sign that PMC is feeling the effects of helping to sustain Cisco's tremendous growth. According to chip analyst Elias Moosa with BancAmerica Robertson Stephens, the reasons for PMC's tumble relate directly to the trials of riding the bucking bronco of Cisco's manufacturing and distribution strategy.
A bit of background: To attain that boring calm Chambers speaks of, Cisco aims to carefully balance its days of inventory, meaning the time it keeps inventory on hand before shipping it out the door. On the one hand, Cisco doesn't want lots of routers sitting around that won't get bought should demand for a particular product lessen. (Think of Dell's (DELL) direct model of building products according to customers' specifications.)
But at the same time, Cisco is trying to please its indirect distributors, basically resellers and value-added resellers like Ingram Micro (IM). Cisco was proud to announce on Tuesday that its tremendous success this quarter can be attributed, in part, to its dominance of the so-called two-tier channel, where it claims to have sold upward of $1 billion in goods in the latest quarter.
To achieve those impressive results, Cisco has to keep enough inventory on hand to be able to meet reseller demand on short notice. How Cisco balances the need to keep inventory on hand with the desire to build products just-in-time depends upon how fast Cisco thinks its suppliers can turn around and deliver the products Cisco needs for its boxes.
Now, Moosa says he thinks the well-documented slowdown in PC sales this year freed up capacity at the chip foundries that PMC contracts with to have its chips built, allowing PMC's products to be manufactured faster. According to Moosa, when Cisco saw PMC and other communications chip companies need less time to supply the chips it needs for its routers, Cisco and the other networkers decided to cut short orders for chips, figuring they could obtain chips fast enough when needed and wouldn't have to stock up in advance.
"Cisco's inventory days went from 55 [days] in the third quarter of last year to 76 [days] in the first quarter of this year," says Moosa. This would indicate a buildup in inventories, which he thinks has caused the company to hold off on buying new chips.
Sandy Harrison with Pacific Growth concedes inventory is a tricky issue as more networking companies follow Dell's lead in just-in-time manufacturing. "There's always an inventory issue; it's a delicate balance," says Harrison. "However, it's more difficult these days with networking OEMs using just-in-time and turnkey manufacturers; the traditional inventory model has changed." Harrison also thinks the market may have overreacted to the yo-yo of inventory. "I thought most of these issues were addressed when the earnings came out and the stock dropped from 46 to 37."
Harrison is looking to the fourth quarter for momentum to return to the stock, as new products come on, including a chip called Freedom, which PMC designed in cooperation with Cisco. Moosa also sees a bottom to the inventory correction toward the end of the current quarter. "In the June quarter, days of inventory went down to 66. Historically a bottom has been 55 days. That tells me that we're well on our way to a correction," says Moosa. "But it's probably going to take the next couple of months, sometime during September," to see a bottom to this.
Analysts have an informal $49 target on PMC for the next 12 months. And at Thursday's close of 32, the stock's price-to-earnings ratio (using this year's projected earnings) relative to its long-term earnings growth rate estimate of 34% is only .79, fairly cheap compared to other companies on our list.
And PMC is a leader in all the important new routing technologies, such as "packet-over-SONET," which Cisco is pushing as the ideal method of sending Internet Protocol packets directly over telephone companies' fiber optic networks. That's a good reason to keep an eye on this stock and to check back in when September's numbers are out. Just keep in mind that PMC is counting on the success of those technologies to make its numbers. Cisco, on the other hand, is hoping to be merely boring.
-- By Tiernan Ray
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