Don't Join This Chip Party
By Monica Rivituso
January 11, 2001
WE HATE TO be party poopers and all, but contrary to the go-go chip buying Wall Street was consumed with Thursday, it looks as if the semiconductor cycle hasn't turned around just yet.
Not that you'd know it by looking at Thursday's chip-stock frenzy. The Philadelphia Semiconductor Index, or SOX, rose 5.8% as investors ignored a handful of bearish research reports — including a couple issued by two of the most prescient names on the Street. Instead, shoppers swooped in to snap up what they viewed as stocks at bargain prices. But they might come to regret their purchases if semiconductor fundamentals continue to deteriorate, as many analysts say they will.
Although chip stocks are certainly beaten down — the SOX is down 52% from its March 1999 peak — their valuations are still two to three times higher than they were during previous industry downturns, says Dan Niles, a Wall Street Journal All-Star analyst at Lehman Brothers. "Thinking a stock that's down 50% is cheap doesn't make any sense," he says.
Investors are wrongly pinning their hopes for the semiconductor sector on the effects of the Fed's rate-cutting, Niles says. Thing is, chip stocks trade on industry fundamentals, not interest rate cuts. And right now, he says, the industry dynamics that he was leery of last year have further deteriorated.
"Semiconductor inventory levels have not declined as much as expected and in some cases (such as Cisco Systems (CSCO)) inventories have increased," Niles said in a report Wednesday. "In fact, the recent data points we are picking up, such as: 1) end demand falling, 2) inventory levels rising and 3) book-to-bills cratering, make us more negative on the fundamentals than before."
For those out of the chip loop, a quick recap on the albatross hanging around the industry's neck: Expecting robust demand for their products last year, chip makers built up inventories early on to prevent being caught short later. Unfortunately, demand for PCs, cell phones and telecom equipment fell off as the economy slowed. And with manufacturers of these gizmos stuck with a stockpile of excess inventory, they ended up ordering fewer chips.
Niles, who was one of the first analysts on the Street to turn bearish on chips last October, is now recommending that investors use sector rallies like Thursday's to sell semiconductor stocks. And if the Fed issues another rate cut at the end of the month (as expected) and the Nasdaq runs up breathlessly once again, Niles again advises selling semiconductors. Sure, the old adage says "Don't fight the Fed." But Niles notes that there's little correlation between chip stocks and interest rates. So he says the better adage here is "Don't fight the fundamentals."
That might be good to keep in mind as we head into earnings season for real — Intel (INTC) kicks off the chip festivities on Tuesday. The key isn't so much the fourth quarter; most of these companies will likely get through those earnings reports. What's important is how they see this year shaping up. On Jan. 9, Motorola (MOT) told analysts on its fourth-quarter conference call that total world-wide semiconductor revenues wouldn't increase 20% to 25% this year as many had previously expected. Now the company is projecting 10% to 15% growth.
But even that might be high. Niles now expects chip revenue growth for this year to be in only the single-digit range. That's quite a comedown from the 37% increase the industry enjoyed last year. He expects this cycle to be similar to the one back in 1988. Then, chip revenues peaked in January 1988, growing 44% year-over-year; by April of 1990, sales had fallen 8% year-over-year. If this cycle follows a similar pattern, it should hit bottom sometime in the third quarter, with growth rates improving in 2002.
Reality Check
Company Fiscal Year 2001 Consensus 2001 EPS ($)* 2000 EPS ($)* Old Merrill EPS Forecast** New Merrill EPS Forecast**
Advanced Micro Devices ends December 2.04 2.37 2.66 2.43
Intel ends December 1.50 1.64 1.56 1.41
Analog Devices ends October 2.54 1.54 2.58 2.39
Linear Technology ends June 1.33 0.88 1.48 1.41
Texas Instruments ends December 1.51 1.25 1.61 1.40
*First Call/Thomson Financial **Merrill Lynch Sources: First Call and Merrill Lynch
Another bearish voice lost in the din of buying Thursday came from Salomon Smith Barney's Jonathan Joseph, who cut his first-quarter and full-year 2001 earnings and revenue estimates on Intel. Describing the PC market as "approaching its weakest condition in nearly 15 years," Joseph thinks it's likely that the entire microprocessor market will be flat this year. This, he says, would make it the worst year since 1986, when the market declined. (Keep in mind that PCs still make up roughly half the overall end market for semiconductors.) With the information he's getting from Taiwanese motherboard makers, chipset makers and memory suppliers being "monolithically negative," Joseph thinks Intel could post a 10% to 15% sequential revenue decline in the first quarter.
Merrill Lynch also lowered its earnings estimates on Intel, along with Advanced Micro Devices (AMD), Texas Instruments (TXN), Linear Technology (LLTC) and Analog Devices (ADI). All-Star analyst Joe Osha said that even though expectations have been cut for many chip makers, consensus earnings figures still seem too high for microprocessor and analog companies. As such, he issued a "reality check" for Merrill's 2001 earnings estimates (see the table above for estimate revisions).
So, while a genuine semiconductor celebration raged Thursday, we're hearing too many cautioning voices to get that excited. If they're right, this party could turn ugly.
smartmoney.com
Author should have Joseph one the first to get bearish on the sector. Niles siad to buy INTC just before it dropped.
Jack |
