Barrons.
MAY 14, 2001
The Chips May Still Be Down
By Vito J. Racanelli
Dow Jones Global Indexes | Global Stock Markets
Shares of European semiconductor makers such as Infineon Technologies and
STMicroelectronics have rebounded 25% or so in the last month from lows.
Like canaries in a coal mine, these were among the first stocks to be snuffed
last year during the technology stock implosion. Logically, they should be the
first to perk up if things get better.
Here's the bull case in a nutshell: Interest rates are coming down around the
world, and that should spur a global economic recovery in the second half;
chipmaking capital expenditure and production capacity have contracted
markedly; and the bad news in PC sales -- which essentially determine chip
demand -- is over.
Infineon CEO Ulrich Schumacher, for example, says capacity and excess
inventory are no longer the problems they once were. "We're around the
bottom," he adds of dynamic random access memory, or DRAM, prices. "We
just need a few positive signals from demand."
Yet that seems more a hopeful than realistic appraisal of the next six months.
It's more likely that a recovery in PC demand isn't as close as the rebounding
prices of chipmaker stocks suggest.
DRAM prices, for one, are down by some two-thirds from September levels.
The price of a standard 64-megabit chip fell below $2 in recent weeks.
Infineon, for example, now is losing money on these memory chips, needing
prices of $3.40 or better to break even.
Sure, DRAM pricing is volatile and can jump quickly, but annual PC growth is
now much more pedestrian than it has been the past few years, points out
Daniel Brem, a portfolio manager with Swiss Life Asset Management.
Evidence from the PC makers is for "3%-4% volume growth, not more." That's
a long way from the salad days of 15% increases or better. And the renewal
cycle for PC sales is probably a bit longer than the chipmakers think, he asserts.
Andy Jackson, a tech-fund portfolio manager at Societe Generale Asset
Management, agrees that the chipmakers are "a bit optimistic." PCs have come
to epitomize tech spending but one might argue that the PC renewal cycle is on
the way out, he says. "We seem to have much of the functionality that we
need," and it's hard to see what in the way of new computer bells and whistles
will get people to buy or upgrade PCs.
Particularly ominous, he points out, was last week's news from Dell Computer
of another big round of cost cuts that will trim as much as 10% of its staff.
When one of the world's most efficient computer makers has such reductions, it
means that not only is the market growing pretty slowly but that there's also
little hint of an uptick soon. More important, computer prices will continue to fall
as a result. That might stimulate demand, but expect Dell and peers to apply the
squeeze to suppliers such as chipmakers this year.
The fortunes of STM are more closely allied to chips used in mobile phones, but
the outlook there is similarly troubling. STM had benefited from better pricing of
flash memory chips for cell phones, notes Christina Karg, an analyst at Park
Place Capital. But she suspects pricing here will also weaken as handset
demand drops off from the fearsome growth seen in 2000. Last year cell-phone
makers expected to sell 600 million unit sales in 2001, a number steadily slashed
to 450 million not long ago. Last Wednesday Siemens admitted that it might be
closer to 400 million.
There are other subtle concerns. With handset makers like Ericsson and Sony
banding together, and others likely to do the same, chipmakers will find the
pricing power shifting to their ever-larger customers. If you don't believe that,
ask any oil-service firm that watched in horror as the big oil companies got even
bigger over the past five years.
Will there be a second correction for the chipmakers? "I think there will be,"
Karg answers without missing a beat.
Sure, technology has changed everything. But chips remain a cyclical business.
Last year saw global chip sales jump 37% to what looks now like a cyclical
peak of $204 billion. It might surprise some investors to learn that after the last
such jump in chip demand -- in 1995 -- that level wasn't surpassed until 1999.
And the U.S., the world's economic engine, is growing far more slowly now
than in the past five years.
One of the industry's most important measures, book to bill, rose to 0.7
preliminarily in April from 0.57 in March, figures Karsten Iltgen, an analyst with
WestLB Panmure. Yet that number has to be one or better for a few months
before there is evidence of a healthy recovery. "We're not there," and the stock
market may yet be disappointed on its hope that things can't get worse, he adds.
Meanwhile, Infineon and STM valuations are high again. And SoGen's Jackson
adds, "It's difficult to see the upside from here."
Infineon, for example, sells at about 30 times consensus earnings per share
estimates of 1.53 euros for fiscal 2002, when analysts are looking for a big
recovery from 0.90 euro this year. STM sells at 25 times next year's
projections. But estimates are very likely to fall further. It should also be noted
that the estimate range is unusually wide. Some see far less growth next year.
Infineon is certainly cheaper than a year ago, so it seems a bargain. That might
have been true when the chip market was growing close to 40%, but it's not
and it's not clear when it will be again.
It won't take much disappointment to make these stocks revisit their lows. And
in the chip business, things are likely to get rougher again before they improve.
Surprise is a legitimate weapon for central banks, but shock is not. Thursday's
move by the European Central Bank to lower its benchmark rate by 0.25
percentage point to 4.50% clearly stunned a market that was expecting nothing
of the kind. The ECB had spent the previous two months expressly talking
down expectations, telling the world that Eurozone growth would be only
minimally affected by a U.S. slowdown and that it was more worried about
inflation, which is running at 2.6%.
Why the quick flip-flop? A slew of data last week indicates the bank might be
wrong about the European economy's ability to withstand slowing global
growth. In Germany, one third of the eurozone output, the figures showed
unemployment continues to rise. Meanwhile, March industrial production grew
at only 1.4% and manufacturing orders fell 4.4%, the biggest monthly drop in
about 10 years, notes Morgan Stanley Dean Witter equity strategist Richard
Davidson.
Davidson calls the cut a positive for the stock market, though he believes a
broad market rise from here is unsustainable, particularly after the 15% rise
from March lows. He worries that corporate profit growth will continue to
worsen, adding he has a downward bias on his estimates of 3% European
earnings growth this year and 8% next.
More sanguine about the rate cut is Jeff Currington, head of equity investment
management for Morley Fund Management. History shows that once a rate-cut
trend gets under way, cyclicals, banks and technology stock prices are higher
12 months later, he says. Yet, Currington adds quickly that the way the ECB
went about it gives him pause about whether this is the start of a downward
rate trend. After this, he adds, the ECB looks more like a squabbling European
Union institution than the forceful Bundesbank.
Thursday's ECB turnabout once again illustrates the inherent problem it faces in
trying to fit one interest rate to 11 economies, notes Stuart Thomson, a strategist
at Sutherlands. The national interest of some members may have been forced
on the entire ECB, "and that's no way to run monetary policy."
It's hard to quibble with the ECB's action, though inflation remains a problem.
But it gets an F for communication skills. The euro weakened on the ECB's cut,
finishing around 87.7 U.S. cents, from 89.3 last Friday.
With the Bank of England also reducing rates by a quarter percentage point to
5.25%, a not unexpected move, the Dow Jones Stoxx pan-European index rose
about 1.4% to 340.96 last week. |
