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Get Four
|  | JANUARY 24, 2006
Analysts' Picks: Tech StocksTop Wall Street pros offer their thoughts and predictions on companies in the tech industryThe third part of our survey of top analyst picks for 2006 across a variety of key industries spotlights tech-sector groups IT Hardware, Internet, Software, and Semiconductors. Part One uncovers top selections in airlines, banking, and biotech, while part two looks at the oil & gas, retail, and steel groups. IT Hardware Investors opening their pocketbooks for IT hardware stocks might want to keep an eye on the new gadgets going into their pockets. Companies that can deliver content to portable devices, from laptops to cell phones, are positioned to deliver strong returns, says Ben Reitzes, managing director and senior IT hardware analyst at UBS. Meanwhile, personal-computer sales are set to decelerate. Reitzes projects that PC sales growth will slow from an estimated 15% in 2005 to 10% in 2006. He points to the length of the replacement cycle for PCs, as well as hesitancy to buy new hardware prior to the impending release of the new Microsoft (MSFT ) Vista operating system. "You may want to be careful where you invest," he says. Reitzes' selections in the sector include: Apple Computer (AAPL ): This is his top pick. Reitzes encourages more positive thinking about the company that asked computer users to "think different." UBS has recommended Apple since Jan. 15, 2004, "and we don't see any reason to stop now," he says. The iPod maker maintains an excellent position in digital personal entertainment devices -- and in merchandising the content that fills them. Hewlett-Packard (HPQ ): The picture also looks promising for rival HP, Reitzes says. For one, the company uses processors from both Advanced Micro Devices (AMD ) and Intel (INTC ). The multiple sources help provide cost stability. Reitzes also likes HP's new management -- CEO Mark Hurd joined last year -- and its prospects for cost-cutting. EMC (EMC ): This data-storage giant is another of Reitzes' picks. He expects solid spending on storage devices this year, and says shares of EMC are relatively cheap at current levels. "There's an attractive opportunity, at least on a valuation basis," he says. (A member of the UBS Wealth Management Investment Strategy & Research team, or one of their household members, owns shares in EMC.) Internet The Internet sector is online for another good year, says Safa Rashtchy, managing director and senior Internet analyst with Piper Jaffray. He sees demand growing from consumers and advertisers alike. But he won't be surprised if Internet stocks slip midway through the year, only to rise again. "As we approach the second half, we generally get more interest in the sector," he says. While Web ads may annoy site visitors, investors might find their growing ubiquity appealing. Rashtchy favors companies dealing in Internet advertising and search rather than e-commerce, where pricing pressure and the increasing cost of getting new customers are squeezing profits. A majority of online revenues will soon be coming from overseas, Rashtchy adds. International markets are growing even faster than in the U.S. as the adoption of Internet and broadband spreads. Rashtchy expects expansion in Russia and China first, then eventually India and Latin America. Rashtchy's favorite names in the group include: Google (GOOG ): The search giant is well-positioned to benefit from the Internet's growth, Rashtchy says. That's because search engines have become a key platform for Internet users rather than just a way to find Web sites or products, he says. Given Google's reputation for innovation, Rashtchy looks for the company to move into new areas, as well. While the stock has taken some recent knocks over concerns that it's too richly valued, Rashtchy responds that Google is a faster-growing company in a much more profitable business. "Investors pay for growth," he says. Netflix (NFLX ): Rashtchy also likes the opportunities he sees in this online movie-rental outfit. The company has essentially beaten out the competition it faced from Blockbuster (BBI ) and others. After vanquishing its foes, Netflix may find an expanding market for its DVD rental service, if not a Hollywood ending. Tom Online (TOMO ): This Chinese wireless Internet outfit stands to gain as online access blossoms overseas. Rashtchy is pleased with the company's diverse service offerings and potential in a country where younger people increasingly use their phones as entertainment tools. "Tom plays right into that," he says. Semiconductors JP Morgan semiconductors analyst Christopher Danely isn't too keen on the sector's prospects for 2006. The day after Intel (INTC ) announced disappointing numbers for the fourth quarter, he said "We're...a little bit cautious on the space." Margins are peaking for Intel, which could lead to growing inventories, and it's a trend he says could spread in the first half of 2006. These factors contributed to the broker's recent decision to downgrade the sector to neutral. Still, Danely sees a few bright spots for 2006, especially for those companies that have undergone strategic restructurings to boost margins. He's also focusing on companies in segments where there's still room to grow. Some examples: Analog Devices (ADI ): For 2006, Danely likes Norwood (Mass.)-based ADI, a company whose specialties include signal processing, the conversion of complex input such as audio recordings and video feeds for a variety of purposes. Among its advantages, the company recently sold its asymmetrical digital subscriber line (ADSL) to Ikanos Communications (IKAN ). According to a recent JPMorgan note, the move enables ADI to shed a relatively small revenue generator with gross margins estimated at 40%. The broker thinks the company's average margins are about 59%, and they haven't necessarily peaked. In a recent note, JPMorgan, which has a banking relationship with Analog, says that measured by calendar year 2006 EPS, the company trades at a discount when compared with competitors such as Linear Technology (LLTC ) and Maxim Integrated Products (MXIM ). Marvell Technology (MRVL ): JPMorgan also has an overweight rating on Marvell. While he likes Analog for its restructuring, Danely says Santa Clara (Calif.)-based Marvell is more of a product play. The communications-focused semiconductor company operates "in a few different areas where demand is doing well." These include aiding the growth of very fast ethernet connections, as well as VoIP and Wireless Local Area Networks. Danely also likes the company's outlook in the storage-chip space. The chips are designed to increase the performance and reduce the power consumption of the most sophisticated hard-disk drives. The analyst calls the area "a very rapidly growing market" with scant competition and high barriers to entry. Microchip Technologies (MCHP ): Danely chooses Microchip as a top pick because he sees the company in a strong position to boost market share and increase its margins, despite the gloomier semiconductor climate. The group produces microcontrollers. Designed to help operate many common machines, from cell phones to cars, these are essentially tiny computers, complete with storage capacity, memory, and a processor. In 2005, Chandler (Ariz.)-based Microchip had sales of about $1 billion in a $12 billion sector, and Danely says it could improve its market share. The company, he says, is gaining momentum against Freescale Semiconductor (FSL ) and other competitors. And in a late November note, Danely calls the stock "one of the most reasonably valued high-quality semiconductor stocks in our universe." Since then, Microchip has climbed about 11%. Software In software, look for one key trend of last year to repeat itself in 2006, UBS analyst Heather Bellini says. There should be opportunities for investors, but overall, growth in the sector won't rise high enough to lift all boats. What UBS thinks will change are the valuations on last year's big winners. The firm has slapped reduce ratings on Salesforce.com (CRM ) and Intuit (INTU ), which recently traded about 224% and 50%, respectively, above their 52-week lows. Bellini says a key factor to look for is a company's capacity to grow independent of macroeconomic factors and the industry as a whole. She's also looking for those companies with the most efficient product cycles, which can adapt the most quickly to fickle buyers. Among Bellini's top selections in the group: BEA Systems (BEAS ): Bellini says BEA Systems (for which UBS makes a market) could thrive as its core product the enterprise software product WebLogic stabilizes and it finds customers for its new product lines. WebLogic is an infrastructure software platform designed to provide customers with a "service-oriented architecture" for their Internet offerings. Bellini says the company is well positioned to capture telecom and cable operator clients looking toward offering customers "triple play" services, data, video and voice through the same cable. San Jose (Calif.)-based BEA is coming out of a rough patch, but Bellini says the company has revamped its salesforce and recovered from the structural problems that dogged it in 1994. Still, it hasn't quite recovered from the slump. BEA "isn't a name that's well liked right now, which we view as a positive," Bellini says. Oracle (ORCL ): Silicon Valley heavyweight Oracle also receives a favorable outlook from UBS. (The firm has a banking relationship with Oracle and its analysts hold stock in the company.) Bellini says Oracle fits well into the UBS model for success in software. Essential to its growth will be continuing strong performance in the applications and database segments. Bellini thinks the database market will reaccelerate, despite tough competition. Coupled with this strong position, the enterprise software outfit has an ace up its sleeve. The company's fiscal year ends in May, traditionally a strong period for annual sales. The combination makes Bellini very confident that the company will hit earnings estimates. 
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