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Home | Research | Member Services | Portable | Media Kit | Help April 1, 2001
Stock Screen: Chip chat
By Lisa Meyer
Red Herring
March 30
There's no doubt that anybody calling a bottom in the chip industry right now is jumping the gun. The lack of sales visibility among semiconductor companies shows that many of them are still working through inventory backlogs. But most analysts agree that 2002 stands to be a good year for chip companies. Indeed, with a few of the stocks already showing signs of revival, we decided the time was ripe to search for semiconductor players poised to be on the cusp of the rebound.
To be sure, some analysts think chip companies will lead the economic revival. In an increasingly competitive global environment, corporations need to optimize their efficiencies through technology, which at a base level depends on integration provided by chips.
"[Despite the current semiconductor slump], the reality is that the number of devices using chips is at an all-time high," says Brian Alger, analyst at Pacific Growth Equities. "Chips will lead us out of the current slowdown -- whether they are going into industrial applications, telecommunications, or consumer electronics."
Keeping that in mind, Red Herring used the Thomson Financial/Baseline stock analysis database to search for chip companies expected to post earnings growth of at least 10 percent in 2002. In addition, to find companies that investors have embraced as of late, we looked for companies whose stock prices have increased year-to-date, an impressive feat in a market as bearish as this one. To capture companies with reasonable valuations, we required that companies trading at less than 28 times 2002 earnings estimates, which is slightly less than the S&P 500 Semiconductor Index's 2002 price-to-earnings ratio of 29.5. To be certain that the stocks are trading at cheaper valuations than usual, we required that their trailing 12-month P/E ratios be below their five-year averages. Finally, we searched for companies that had at least $200 million in market capitalization. Data used for this screen were current as of March 27.
The screen yielded 14 companies: ASM International N.V. (Nasdaq: ASMI), ASE Test (Nasdaq: ASTSF), Cirrus Logic (Nasdaq: CRUS), Dallas Semiconductor (NYSE: DS), Elantec (Nasdaq: ELNT), ESS Technology (Nasdaq: ESST), Genesis Microchip (Nasdaq: GNSS), International Rectifier (NYSE: IRF), Lattice Semiconductor (Nasdaq: LSCC), LSI Logic (NYSE: LSI), Micron Technologies (NYSE: MU), Power Integrations (Nasdaq: POWI), General Semiconductor (NYSE: SEM), and Zoran (Nasdaq: ZRAN).
Red Herring decided to focus the screen on Micron Technology, Zoran, and LSI Logic, three companies expected to post incredibly large earnings gains next year. Granted, any earnings increases coming off the 2001 profit slump will most likely be extreme. But such significant growth in 2002 does provide evidence that these companies will be on the cusp of the rebound. These three are expected to post earnings increases of 139 percent, 107 percent, and 173 percent, respectively, in 2002. For 2001, analysts predict that LSI Logic and Micron will report declining earnings, whereas, for Zoran, they predict a 7 percent earnings increase.
KEEPING COSTS DOWN IS KEY
That Micron Technologies can weather the current semiconductor slump better than competitors is due in large part to its ability to develop products at low costs. The company postponed the announcement of its fiscal second-quarter results last week, because its electronics division delayed reporting its results. Micron's full earnings report came out on Thursday after the market closed, and the company posted a 1 cent-per-share loss from continuing operations, 2 pennies per share less than what analysts were expecting. Micron's semiconductor business was slightly profitable.
But Micron said last week that it would be slightly profitable on $1.05 billion in revenues, even though gross profit margins sequentially shrank to 19 percent from 49 percent. Indeed, the pricing for DRAM chips, which are the main memory chips used in PCs and are Micron's primary product, may have been down 50 percent sequentially, but the company's quarter-over-quarter bit growth increased 30 percent, according to Tim Mahon, analyst at Credit Suisse First Boston. The fact that the company can still earn money in the face of immense price pressure only highlights the company's ability to produce at low costs.
What may be even more important about Micron's preliminary earnings statement, however, is that the company said it is no longer shipping its products into inventory backlogs. Rather, its DRAM chips are now reaching end consumers. "At least in terms of Micron's business, DRAM inventory is in line with PC manufacturers," says John Geraghty, analyst at Gerard Klauer Mattison & Co.
Does this mean that at least the DRAM chip market has hit bottom? At the very least, Micron's numbers show that the end might be near. And what better time to invest in one of the sector's leaders? Micron's stock is currently trading at a trailing 12-month P/E ratio of 20, compared with its five-year average of 39.
CAPITALIZING ON DVD GROWTH
Like most chip companies, consumer electronics semiconductor provider Zoran has received some hits lately because of slowing PC demand. After the closing bell on January 18, the company did meet its revised guidance for the fourth quarter but then had to ratchet down analysts' expectations again for the first quarter. Adding to that disappointment, Zoran said that it expects revenues to decrease sequentially by approximately 5 to 7 percent in the first quarter. The company's stock fell 19 percent the day after the news was announced.
But a few weeks later, the company announced a stock repurchase program of up to $10 million during a 12-month period ending January 29, 2002, sending a message to long-term investors that the company believes the stock is attractive at current levels. Despite the slowdown in PC sales, what intrigues us the fact that Zoran is the market-share leader in supplying chips for DVD players, a hot market indeed. The number of DVD players increased 65 percent during the past year, according to Mr. Alger. "The DVD market will continue to grow during the next three to four years at similar clips because of the low U.S. penetration and an increase in adoption on a global basis," he adds.
Zoran is also increasing its market share in another quickly growing consumer electronics market: digital cameras. The company's first-quarter earnings will suffer from delays in digital camera sales resulting from the inability of Zoran's customers to produce a product suitable for delivery. But Zoran recently announced a new design for camera manufacturers, as well as an alliance with flash memory storage product provider SanDisk (Nasdaq: SNDK) to accelerate the development of more sophisticated digital cameras and flash memory cards.
And investors have rewarded the prospects of Zoran's markets, bidding up the company's stock 2 percent year to date. With a trailing 12-month P/E ratio of only 22, compared with a five-year average of 101, Zoran's stock is a more than reasonable buy.
CONSUMER ELECTRONICS IN DEMAND
Zoran's markets are so attractive that LSI Logic wants to get in on them. LSI Logic recently agreed to buy Zoran's rival, digital video–encoding provider C-Cube Microsystems (Nasdaq: CUBE) to penetrate the broadband entertainment markets. In fact, the semiconductor industry is one of the few areas that is experiencing a decent amount of merger and acquisition activity lately. Maxim Integrated Circuits (Nasdaq: MXIM) agreed to buy another company on this screen, Dallas Semiconductor, for $2.5 billion in January, for example. We find it encouraging that larger companies having been taking advantage of the low valuations of struggling competitors to increase market share and product offerings.
With the acquisition of C-Cube, LSI Logic's bolstered consumer electronics division might offset the slowdown in its communications and storage businesses. Indeed, the company recently warned that its first-quarter revenue and earnings would come in below forecast. LSI Logic now expects that first-quarter revenue will sequentially decline approximately 30 percent, versus prior guidance of a 12 percent reduction. "But once the overall inventory situation is corrected, LSI's communications and electronic consumer products are in robust markets," says David Duley, analyst at Wells Fargo Van Kasper.
Plus, LSI Logic has several of its own manufacturing facilities, a large fixed cost that can hurt a company during downturns. But when business is booming, chip makers with their own facilities can develop products at a faster rate. As a result, analysts expect earnings to increase in 2002. But the stock is still cheap, trading at a trailing 12-month P/E ratio of only 15, compared with the company's five-year average of 43.
So even though the bottom to the semiconductor market is still a ways off, we recommend buying industry leaders now, when their stock prices are so depressed.
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