News : Friday, January 30, 1998
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Despite recent gains, semiconductor stocks are
expected to suffer
Merrill Lynch lowers its outlook for the sector again;
the culprit, no surprise, is Asia
By Michael Brush
Technology stocks have rebounded nicely as the markets
begin to feel more confident about Asia. Among them
have been many of the companies that make computer
chips and the equipment used to produce and test them.
But don't be fooled. These semiconductor stocks are
still in for a rough ride. Indeed, the near-term
outlook for the group took on a bleaker tone Thursday
when Merrill Lynch analysts once again adjusted down
their expectations for the stocks.
In a conference call with brokers and money managers,
Merrill Lynch analysts Tom Kurlak and Robert Stern
notched down their expectations for the sector's
performance in 1998.
Kurlak, who covers semiconductors for Merrill Lynch,
says weak demand and overcapacity mean things are
going to get worse for the sector before they get
better. He says the group will test new lows sometime
soon, after having recovered somewhat from the last
selloff that peaked in December.
"The semiconductor makers are grudgingly accepting the
fact that there is a slowdown," says Kurlak. "And they
are holding out for recovery in the second half. But
we are doubtful about that because of a worldwide
slowdown this year."
Part of the problem is a slowdown in demand for the
products that use chips and, Kurlak cautioned, little
reduction in capacity going on. What's more, he said,
many of the big Korean chip makers plan to
aggressively exploit the weakened Korean currency to
increase their global sales.
Stern, who covers the companies that make equipment
used to produce chips, says he now expects growth of
only 0% to 5% for the year, down from his previous
forecast of 5% to 10%. U.S. companies like Texas
Instruments (NYSE: TXN) and Motorola (NYSE: MOT) plan
to spend more on chip equipment. But that will be more
than offset by a slowdown in spending by Asian
companies.
Merrill Lynch analysts held the conference call in
part to warn investors not to get fooled by a rebound
in the market for DRAM chips in January. That rebound
gave the impression that the highly cyclical chip
sector may be coming off a low point in its cycle.
Like the Merrill Lynch analysts, however, Cowen
semiconductor equipment analyst Tai-min Pang believes
it is not. Instead, the faux rebound was due to a
quirk in the market caused by the Asian economic
crisis.
Here's what happened. Around the end of last year,
says Pang, many chip makers in Korea had trouble
getting credit to buy raw materials. The result: firms
like LG and Hyundai had to close down production. And
to make up for the lack of credit, they dumped their
DRAM inventory on the spot market to raise cash.
At the same time, explains Pang, many personal
computer makers, uncertain about the future, also
cleared out their DRAM inventory and sold it in the
spot market, without ordering more. Both events drove
down the cost of DRAM, pulling the chip stocks down as
well.
By January, the DRAM producers had stopped clearing
out their inventory. "And all of the sudden PC makers
realized they did not have enough so they had to go to
the spot market," says Pang.
That raised DRAM spot prices short-term, giving the
false impression of a turnaround off the lows of the
cycle for the sector. But it wasn't, analysts say.
"You want to be careful not to mistake an increase in
orders in January from December as a pick up in the
sector," warns Kurlak.
Why isn't it a genuine upturn? The Korean producers
who had to sell inventory to raise cash are now
producing again. Their DRAM should hit the market in
March. And that will send DRAM prices back down again.
"I would be surprised if the price of DRAM did not
start to fall again at the beginning of March," says
Pang. And the prices of chip stocks, which track the
price of DRAM, will follow.
"In the next quarter or two we could actually see the
bottom," says Pang. After that, the stock prices of
chip and chip equipment maker stocks should start to
recover. "In six months time most of these stocks will
be priced on 1999 earnings. And I am fairly confident
that 1999 will be an up year from 1998."
The upcoming dip in chip equipment stocks that should
occur may present a good buying opportunity for the
long term investor, Pang thinks. He recommends buying
chip equipment stocks when they hit their "trough
valuation." That is the level at which a stock's price
to sales ratio (market capitalization divided by
trailing twelve month's sales) is as low as it was the
last time the overall sector was in the bottom of its
cycle.
There are at least three chip equipment stocks
investors should keep an eye on and buy when they hit
their trough values, according to Pang. For example,
he says the last time the sector bottomed out, Dupont
Photomasks (NASDAQ: DPMI) had a price to sales ratio
of 1.3. That's a "trough valuation" of about $22 or
$23 in today's market. The stock's current price to
sales ratio is about 1.6.
Another stock Pang likes, Lam Research (NASDAQ: LRCX),
bottomed out last time at a price to sales ratio of
0.6. That implies a trough valuation of $17 or $18 in
today's market. The stock's current price to sales
ratio is about 0.7. Finally, PRI Automation (NASDAQ:
PRIA) will hit its trough valuation if the stock
returns to about $22. At that point, the stock will
have a price to sales ratio of 2. The current price to
sales ratio is 2.5.
Pang's is an interesting approach. But don't forget:
Calling the bottom of any market - not to mention one
in the midst of an economic crisis -- is tricky at
best. |
