Chip Players: Survival of the Fittest

With first-quarter results poor and memory prices plummeting, sales growth is expected to slow for this year. Still, many will earn profits

by Karen Kawaguchi From Standard & Poor's Equity Research

Dramatic declines in the average selling prices (ASP) of a few key segments appear to be a thorn in the side of the semiconductor industry in 2007. Market estimates for annual sales growth were recently slashed to 2%, from a range of 6% to 10%. The segments that are particularly under pressure are DRAM (dynamic random access memory), NAND flash (nonvolatile memory used in consumer electronics products), and microprocessors (used in PCs).

Standard & Poor's agrees industry growth will likely moderate this year.

"We think sales growth will slow down primarily for two reasons: First-quarter results for semiconductor companies were poor and will affect annual results. Also, memory prices dropped sharply," says Clyde Montevirgen, an S&P equity analyst.

Nevertheless, Montevirgen remains bullish on most of the sector.

Healthy End Markets

"Even if sales increase by only 2%, most semiconductor companies stand to benefit from operating leverage and more favorable sales mix, and can still make a decent profit this year. We expect that global sales will still exceed 2006 industry revenues, which were around $248 billion," he says.

The semiconductor group, which makes up 2.28% of the market cap of the S&P 1500 composite index, rose 13.4% this year through June 22, vs. a 6.5% gain in the S&P 1500.

Key end markets continue to be healthy, despite declining product ASPs, according to most observers. PC unit sales are set to grow 11% in 2007, according to research firm IDC (IDC). The mobile handset market, which shipped one billion units in 2006, is forecast to expand 10% this year, IDC forecasts. And the consumer-electronics market, including digital TVs and gaming devices, should see a 7% rise in revenues this year, according to the Consumer Electronics Assn.

Montevirgen believes many chip makers will be profitable this year, including Intel (INTC; $24), Texas Instruments (TXN; $37), Microchip Technology (MCHP; $38) , On Semiconductor (ONNN; $10), Cypress Semiconductor (CY; $23), Spansion (SPSN; $11), and Integrated Device Technology (IDTI; $15) . S&P maintains 4 STARS (buy) rankings on all those stocks.

AMD's Difficulties

Intel began restructuring in September, 2006, and it began to pay off in the first quarter of 2007, as the company regained market share against Advanced Micro Devices (AMD; $15) in the microprocessor segment. Montevirgen thinks Texas Instruments will benefit from robust end markets and market share gains in lower-end handset chips and high-end analog chips. The analyst upgraded On Semiconductor to 4 STARS (buy) from 3 STARS (hold) on June 22.

"ONNN has diversified sales, but also has notable exposure to the computing and wireless markets, which I think will provide good growth prospects starting in the second half of 2007," says Montevirgen.

The adjusted sales growth forecast may cast a pall on a few companies, including Advanced Micro Devices, Micron Technology (MU; $13), and Maxim Integrated Products (MXIM; $33). Each of those stocks is ranked 3 STARS (hold).

Even before the forecast was cut, Advanced Micro faced narrowing margins and market share losses to Intel. Micron's main products, DRAM and NAND, are sensitive to industry factors, such as global memory supply and demand. Although analog chip maker Maxim may generate healthy revenues, it is seeking growth in lower-margin businesses, which is likely to limit gross margin expansion and profitability. Montevirgen is quick to emphasize, though, that these stocks remain in the 3-STARS category.

Intel-AMD Duel Heating Up

S&P expects continued volatility for DRAM and NAND prices. Prices for the benchmark 512-megabit DRAM fell to less than $2 per chip in May, 2007, from about $6 per chip at the beginning of the year, according to research firm Gartner (IT). S&P believes these prices are rebounding, at least temporarily. Dramexchange, Asia's leading spot market, reported that pricing for this type of DRAM rose to $2.70 on June 25. NAND prices have also plummeted, but may be on a transitory upswing. Spot pricing for an 8-Gbit NAND chip, for example, was about $9.50 in early December, 2006, fell to the $5 range in January, 2007, and then rose to $7 on June 25.

In the microprocessor segment, another chapter in the battle between Intel and Advanced Micro will unfold, as each promises to release a faster, more powerful chip later in 2007. Intel claims its new Penryn chips will be competitive with the performance of Advanced Micro's Barcelona chips, but the company has not yet released meaningful benchmarks for its new processor. Intel may have a leg up on AMD on production, given the high volume capabilities on more advanced process technologies.

"We also think Intel will lower their prices for some of their products ahead of the release of new chips to hold market share against AMD," adds Montevirgen. Intel claimed an 80% share of the global microprocessor market as of the first quarter of 2007.

Kawaguchi is a reporter for Standard & Poor's Global Editorial Operations.