09:45am EDT 12-Aug-98 Lehman Brothers (M. A. Gumport, CFA 1(212)526-5368) ALSC
Semiconductors: Fundamentals on Track for a Bottom
Today's Date : 08/12/98
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* Fundamentals on track: DRAMs up; C-Cube Microsystems (CUBE - 17 1/8, 1)
wins key order.
* Decline in chip stocks reflects stock market, not fundamentals.
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STOCK MARKET DOWN, BUT SIGNS OF BOTTOMING CHIP MARKET CONTINUE. Other than
the gyrations of the stock market, news is relatively slim in the past few
days since we indicated our growing conviction that chip stocks fundamentals
(and stock prices) were bottoming. On the fundamental front, the key news is
that a broadening selection of DRAM configurations are now moving up. This is
clearly good news for Mircon (MU - 30 11/16, 2), and, to a lesser extent, for
Alliance Semiconductor (ALSC - 2 11/16, 1). Also, commodities were first to
feel the slump and may well be among the first sectors to emerge from the
slump. Elsewhere, C-Cube Microsystems 8/10 confirmed it had won the DIRECTV
Los Angeles Broadcast Center (LABC) compression business. The potential of
that win was a key reason for our recent upgrade of CUBE. We are still sizing
the importance of LABC, but our first impression is that the DIRECTV
relationship alone could boost CUBE's total sales by 10-15% over the next 2
years. THESE POSITIVE FUNDAMENTAL EVENTS HAVE NOT PREVENTED A SELL OFF IN
CHIP STOCKS AS THE MARKET DECLINES, BUT WE BELIEVE OUR THESIS IS INTACT.
THESIS IN A NUTSHELL. Chip stocks are in the midst of their worst-ever
performance (the S&P 400 has moved up 91% since September 1995 but the average
chip stock has moved down 31%). Fundamentals, too, have been the worst ever
(1998 world chip sales headed for a 10%-12% decline, 10-year average growth
will fall to a record low 11%). Valuations are at record lows (9 of the 17
chip stocks we cover now trade at record low relative multiples of book and
sales) including Alliance Semiconductor, Avnet (AVT - 52 3/8, 2), CUBE,
Integrated Device Technology (IDTI - 6 1/8, 3), Ramtron (RMTR - 2 7/16, 1),
STMicroelectronics (STM - 64, 1), Xilinx (XLNX - 41 1/32, 1), Lattice
Semiconductors (LSCC -30 9/16, 2) and Micron. We expect a strong upturn in
4Q98 results for chip makers based principally on large volumes of low priced
($399-799) PCs, ongoing telecom/data networking strength (most notably at
Cisco; Lucent and Alcatel now also frequently mentioned and Nokia in the
wireless space), the emergence of DVD and cable data modems, and increased
volume of digital broadcasting. XDSL sales should begin, too, although high
volume is a year away. In general, growth drivers are shifting from high
priced PCs to low priced PCs and digital video (including, in digital video,
tremendous pressure on communications bandwidth).
STOCKS. We continue to feel we already own the right names. Vitesse (VTSS -
34 7/8, 1) is our single best story. Among smaller cap issues, XLNX still
lacks momentum, but it is exceptionally well positioned (high margins) and, we
believe, will retake market share. CUBE is a slightly lower margin story with
difficult issues in China which will keep 3Q EPS flat/down, but the DIRECTV
order highlights its opportunity as the key play in digital video. Among big
cap stocks, Texas Instruments (TXN - 58 9/16, 1) will have by far the best
margin improvement in the next year, and STM is by far the best long term
story of consistent outperformance. We believe venture situation RMTR will
get back on course over the next 9 months. In the past 8 weeks, we have twice
upgraded MU (memory coming back into balance between Sept. and April; better
pricing evident now) and once upgraded ALSC (value story). And, while our
long term thesis on changes in the x86 market is totally unchanged (a shift to
low priced devices and increased competition), we recently upgraded both INTC
and AMD. INTC seems to see business progressing as expected towards a good 4Q
upturn, and a "trading buy" appears appropriate on a near term basis.
206.253.196.27 |
