Semi-OT SMARTMONEY.COM: Is The Chip Cycle Turning?
By MONICA
NEW YORK -- When it comes to semiconductor stocks, sentiment is rarely lukewarm. Usually, the sector is either being fervently plugged or viciously punished on Wall Street. But then there are times like these when sentiment is in transition. Have you noticed? All you can hear lately is noise.
One thing is starting to come clear, however: Chip sales are slowing faster than many had expected. The Semiconductor Industry Association reports that industry revenues will continue to grow next year, but at a projected 22% rate, not the 25% previously anticipated. Fears of a slowdown have soured sentiment so badly that it looks as if the great chip run of the past year and a half might be ready for a sustained breather. Just look at the Philadelphia Semiconductor Index - it's fallen 50% since March and now sits 5.6% lower year to date.
The problem is multifaceted, really, but it all gets back to demand. For starters, PC sales are slowing and business in Europe is lackluster. With roughly half of all chips manufactured for use in computer hardware, preannouncements from Intel (INTC), Dell (DELL) and Apple (AAPL) have weighed heavily. Cell-phone manufacturers Motorola (MOT) and Ericsson (ERICY) also sparked worries about weaker-than-expected handset sales - one of the fastest-growing end markets for chip makers. And chip-equipment maker Kulicke & Soffa (KLIC) didn't soothe investor worries when it announced customers were pushing out, or delaying, their orders.
Bring in the Bears
Meanwhile, Nortel (NT) and Lucent Technologies (LU) - big consumers of communications chips - clearly showed slower growth in their latest quarterly reports. And Cisco's (CSCO) results on Monday served up another worry point. The network-equipment powerhouse delivered a good quarter but reported a whopping 335% sequential increase in "raw materials" - namely chips. Cisco, like many technology companies, has been building up inventory to avoid being caught short later. But now those inventory levels will likely have to be whittled down - meaning chip makers expecting hefty orders from Cisco such as PMC-Sierra (PMCS), Galileo Technology (GALT) and Broadcom (BRCM) could be left hanging.
It should be noted that none of these companies have expressed such concerns. In fact, Broadcom's management went so far as to issue a press release Thursday saying the company is comfortable with analysts' fourth-quarter estimates. But that hasn't soothed nerves much. "Changes in the semiconductor world usually are not moderate: This sector is black or white," says Terry Ragsdale, a Wall Street Journal All-Star analyst. "We suspect that the next couple of quarters are going to look like a full down cycle, with shorter lead times...and weaker pricing."
Ragsdale, a longtime chip bull, changed his tune last week, saying he was now in "avoid mode" with these stocks. The biggest problem is that the evidence of a slowdown in demand and an impending inventory correction fly in the face of Wall Street's current earnings estimates for the sector. Forecasts, according to Ragsdale, reflect an industry upturn, not the slowing profit growth he's expecting. While some of these stocks have already been cut in half, they could very well end up being halved again, he says.
"The problem with the stock point of view is once you start messing with the 'E' [earnings], you're going to start pounding the P/E," Ragsdale warns.
Not So Fast...
Of course, not all industry watchers agree with the gloomy industry outlook, especially market researchers. Mary Olsson, principal analyst for Dataquest, insists that while sales are, indeed, slowing, healthy double-digit growth this year and next is nothing to scoff at. More macro concerns - such as a slowing economy, a weak euro and higher oil prices - aren't enough to clobber chip makers either, she says. There may be some macro affect on the industry, but nothing like the doom and gloom some on Wall Street are predicting, she says.
Brian Matas, vice president of market research at IC Insights, also notes that while these companies are spending a fair amount of money to bulk up manufacturing capacity, their expenditures haven't reached a dangerous level. "We really haven't seen that many red flags to give us any indication that the sky is falling like some of these people are saying," says Olsson.
But many analysts think these stocks have further to fall. Although there's some debate here, risk-adverse investors might want to stand on the sidelines until all of the bad news is fully digested. That, according to some estimates, could take up to six months.
"I think we've got a long way to go and I would really recommend investors not look at this as a buying opportunity because most people have not necessarily accepted the fact that there is a problem," says Dan Niles, an analyst at Lehman Brothers. "Not every dip is a buying opportunity. Some dips are just dips and they're going to stay there for a while or get worse. There are several examples of that. Lucent's a great one."
What to Do?
On the one hand, on the other hand. Not much help, right? Well, Ed Vroom, co-manager of the Reserve Small-Cap Growth fund (REGAX), thinks most investors would be best to take the long-term perspective. There's no doubt that the industry is highly cyclical, but over the past 25 to 30 years, industry sales have grown an average of 17% annually - an impressive record for any industry, Vroom says.
For that reason, he suggests investors should carry a core chip position in their portfolios - even through the downturns. And right now he disagrees with Niles. He thinks the market has overreacted to the point where many chip-stock prices reflect little or no sales growth.
"My feeling is that this is probably a very good opportunity to accumulate some companies that have good, long-term prospects," he says. "That's typical of what happens at bottoms. You get everybody throwing in the towel and you create a bottom for these stocks. I think that for a lot of them - say if you buy an Applied Materials (AMAT) or a KLA-Tencor (KLAC) - you own the franchise company in an industry that has exceptional long-term growth prospects. That's the bottom line."
Vroom may have a point. After all, Applied and KLA-Tencor are trading at around 13 times next year's consensus earnings estimates. But whether you buy now or buy later, you can expect some short-term turbulence.
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Jim |
