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To: Les H who wrote (2592)	8/28/2002 9:43:23 AM
From: Les H	Respond to of 29594

Semis? Not just yet. morganstanley.com We are zero-weighted in the European Model Portfolio in semiconductor stocks, while Stuart Adrian and team have an Attractive industry view. Given that the Philadelphia Semiconductor index (SOX) more than halved (it fell 55%) between early March and early August, we have taken another good look at the group, but essentially cannot find any value. The positive side of the debate has four angles: (1) weak trailing relative performance, (2) DRAM prices that are off their lows, (3) global semiconductor company revenue growth troughed in August of last year and should show positive year-over-year growth as early as next month's data release (for July), (4) price/sales valuations are back to their troughs of last year. We view the negatives as more compelling. First, on valuation, although the European names are at their one-year lows on price/sales, they are still well above the 1998 troughs. At that time, the sector troughed at 1.3 times trailing sales, while it now trades on over 2 times. More importantly, what is a fair price/sales ratio anyway? Our work regresses EBIT margin and asset turnover (independent variables) against prices/sales (dependent variable). We find that using STMicro (US$20.07) as an example, a ratio of between 0.4 and 2.5 is reasonable, depending on whether you are using trough or peak margins and turnover. With the stock currently on 2.6 times sales, it looks expensive. Most worrying, the industry has not rallied sustainably since the August 2001 turn in global semi revenue growth. Given that future top-line growth is unlikely to match that achieved historically, semis should de-rate relative to their own past. Could it be that they are in a period of secular derating toward the range that we think is justifiable on fundamentals? It's likely, we'd argue. Otherwise, note that at US$2.30 for a 128mb DRAM chip, DRAM is now selling below the cash cost of production. We were negatively surprised that DRAM pricing has not been more resilient through the seasonally strong back-to-school period. Bottom line: Don't be tempted by "cheap" valuation. We would wait either until the sector trades down to 1-1.5 times sales or until there is early evidence of a stronger PC market.