OT not BRCM related but Semi related
From Business Week Yesterday
Q&A: Chip Stocks Should Hang Tough
S&P's Brendan McGovern sees a '99 chip industry rebound after a weak '98
Decisions the Federal Reserve makes at its late June meeting will dictate the future direction of the market, but higher long-term interest rates are already causing stocks to decline, says Brendan M. McGovern, Standard & Poor's semiconductor analyst. Stocks with high price-to-earnings ratios are particularly hurt by higher interest rates because, the way investors see it, the higher interest rates are, the lower the value today of a company's future earnings.
Still, McGovern says semiconductors have been a good place for investors to be, especially since October. He discussed a number of trends affecting the chip industry and shared his favorite large-cap and small-cap stock picks in a June 8 chat hosted by Business Week Online on America Online. Here is an edited version of McGovern's responses to questions from the online audience and from Business Week Online moderator Amey Stone.
Q: The market had another disappointing day today [June 8]. The Dow was down 144 points and the tech-heavy Nasdaq was down nearly 50 points. What brought this about?
A: It appears that the biggest factor driving the stock market right now is interest rates. The long bond yield spiked over 6% today, and this is certainly a negative for stocks, particularly technology stocks, since higher interest rates decrease the present value of future earnings. That said, a 6% yield is still relatively benign. Going forward, investors will be focusing on the June Fed meeting to determine the direction of the market.
Q: How did the semiconductor sector hold up today? And how is it doing in general lately?
A: Like most areas of technology, the semiconductor sector has done very well, particularly since last October. It's true that over the past few months chip stocks have come back down somewhat due in part to higher interest rates and high valuations. Still, on a year-to-date basis, semiconductors have been a good place for investors to be. In my coverage universe semiconductor stocks are up 37% year-to-date, while semiconductor equipment stocks are up 21%.
Q: What do you think of LSI?
A: LSI has been the best performing stock in my coverage universe this year, rising 145%. The company has changed its focus to address a broad segment of vertical markets, including the storage market with its acquisition of Symbios. I currently have an accumulate recommendation on the stock. The current valuation of about 21 times my 2000 earnings per share estimate is attractive given that the company is addressing rapidly growing end market segments and is showing very strong margin improvement.
Q: The Semiconductor Industry Assn. said today that total semiconductor sales should reach $141 billion in 1999. Will that be good for the sector?
A: That forecast is about in line with most analysts' expectations and represents about a 12% increase from last year's level. It is important to note that a 12% rise is actually a bit below the industry's historical long-term growth pattern of roughly 17% [a year], but this also represents a significant improvement over the industry's growth over the past three years. In fact, a 12% rise in 1999 would be a dramatic turnaround from 1998's decline of more than 8%.
Q: IBM, Compaq, and other tech stocks were hurt today by a Goldman Sachs report predicting that demand for computers would be weaker in the next few months. Do you agree? And what would be the effect on chip stocks?
A: I did not see the Goldman report, but a number of analysts have speculated that corporations will lock down information technology spending in the second half of this year in response to the Y2K computer bug. It is difficult to assess what the final impact might be, but current indications point toward continued strong demand for PCs. Any Y2K disturbance should prove to be short-lived. As far as the impact on chip stocks goes, certainly those companies that supply PC companies would be impacted by any slowdown, but the communications market is increasingly emerging as an important demand driver for chips. We think this trend will continue over the next several years.
Q: Overcapacity in DRAM [memory chips] was a key reason for the slump in the chip industry. Is that still an issue?
A: The DRAM market is one of the largest and most important of the chip sectors. In recent months DRAM prices have fallen sharply, and this will certainly impact the profitability of Micron Technology, the lone U.S.-based DRAM manufacturer. The semiconductor equipment stocks could also be impacted by continued overcapacity in this sector since further pricing pressures would likely result in a decrease in DRAM capital spending.
A countervailing trend, however is the continued migration from 0.25 micron processing technology to 0.18 micron and below. As companies advance the rate of technology, it becomes increasingly necessary to spend heavily for new capital equipment. In the near term, we believe DRAM companies will continue to spend despite the recent decline in the DRAM pricing environment.
Q: Do you see the recovery in Asia continuing, and how does that impact the companies you cover?
A: In recent quarters, Asia has certainly been a positive surprise across the board -- albeit from a much smaller base than in recent years. Some areas in particular that have shown strength include Taiwanese foundry spending for capital equipment. Foundries are companies that manufacture chips for firms that do not have manufacturing operations of their own. Over the past few months, these foundries have experienced very high capacity utilization at the leading edge, and this has necessitated heavy spending for new equipment. In general I would expect Asia to be a solid contributor to chip industry growth over the course of this year and into next year.
Q: What about Applied Materials? I hear it is doing well.
A: Yes, it is. I currently have a buy rating on Applied Materials. Last quarter was an absolute blowout. AMAT beat the Street's expectations on all fronts, including sales, earnings per share, and new order growth. Market share gains in a number of sectors have been a big driver for the company. In addition, the company underwent significant restructuring during the last downturn and has emerged as a much leaner company. We expect AMAT's dominance of the semiconductor equipment industry to continue and recommend purchase of the shares.
Q: For investors interested in playing growth in the Internet sector, are there any semiconductor companies to look at?
A: Certainly the growth of the Internet is fueling the chip industry as well. Companies like Texas Instruments, Altera, Xilinx, and LSI Logic enable the buildout of the networking infrastructure and therefore the proliferation of the Internet, so you can certainly characterize these stocks as Internet plays. I would also throw in Applied Materials and KLA Tencor since both of these companies make the equipment that makes the chips.
Q: Will we continue to put up with chip dumping from the Koreans?
A: Unfortunately this is something that is sometimes out of our control. Micron Technology CEO Steve Appleton is a frequent speaker on Capitol Hill and is trying to raise awareness of the problem. Unfortunately, many Korean DRAM manufacturers have the backing of their government and therefore they do not always act in a rational manner. But, given the recent problems in the Korean economy and the fact that the International Monetary Fund had to bail the Korean government out, I think those companies will be under more pressure going forward to focus on profitability rather than just market share. This should help to alleviate some of the dumping problems as marginal DRAM manufacturers exit the market.
Q: If an investor wanted to buy one stock in your coverage area, which one would you recommend? Would it be smarter now to go with a chipmaker or a chip equipment maker, and which one?
A: I would caution investors that both of these segments are highly cyclical and highly volatile. For long-term investors, I think Texas Instruments is an excellent core holding. The company dominates the rapidly growing digital signal-processing segment of the chip market and has competitive advantages that should enable it to maintain its dominance for some time. Applied Materials is another company that is the dominant force in its served markets. AMAT, however, is highly volatile and should be purchased only by aggressive investors who can stomach the ups and downs.
Q: Which company do you prefer, Intel or Advanced Micro Devices?
A: No contest. We would be buyers of Intel, but we are not huge fans of AMD. While Advance Micro Devices has excellent technology, the company has stumbled time and time again on the manufacturing front and has been unable to generate acceptable yields in its manufacturing process. This is a big reason why the company has struggled from a profitability standpoint. AMD is expected to launch its K7 chip later this year. This should help the company move up the food chain somewhat. Still, a majority of AMD's sales will be into low-end PCs where pricing is brutal. Bottom line: We think Intel will continue to be the winner in the microprocessor segment.
Q: Are there any lesser-known companies you follow that you think audience members should check out?
A: Sure. One small-cap company that has an interesting story is Photronics (PLAB). PLAB is a leading manufacturer of photomasks. These masks are a small but integral part of the semiconductor manufacturing process. Over the next 12 to 18 months, we think the demand for the company's masks will improve as chipmakers continue to migrate toward chips with smaller and smaller feature sizes. This trend should fuel PLAB's earnings growth and stock price.
Vischy Intertechnology (VSH) is another small company to look into. The company, which has a market cap of about $1.5 billion, supplies passive electronic components to a broad base of end markets. These components are decidedly low-tech in nature but can be found in virtually all electronic devices. Recent pricing trends have improved and the company's restructuring efforts should allow for much stronger profitability over the next year or two. The shares have had a good run in just the last few months, but at only 16 times our 2000 earnings per share estimate, we think there is room for more expansion.
EDITED BY LORI BONGIORNO
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