Markets & Finance

Chipmakers' Circuits Are Humming


By Tom Smith Through mid-January, the semiconductor industry has enjoyed a bullish earnings reporting season. The world's largest chipmaker, Intel (INTC

; ranked 5 S&P STARS, or buy; recent price: $33), reported a quarterly record in revenues of $8.74 billion for the three months ended December.

"Ongoing strength in emerging markets, coupled with improving demand in established markets," drove revenue growth, says Intel. Put another way, Asia is back to boom-time performance after the SARS slowdown in spring, 2003, and the U.S. economy is beginning to rev up again based on low interest rates and tax cuts, among other things.

FATTENING MARGINS. Standard & Poor's believes a lot of computers and other technology gear bought back in the 1999-2000 boom are beginning to look obsolete. Intel is pushing wireless Internet connectivity as a new, higher standard for laptop PCs (see BW Online, 1/15/04, "Intel: Powered Up for Another Hot Year"). A similar move to higher functionality is happening in wireless phones with color screens, cameras, and better battery performance. We think the need to replace aging equipment, coupled with an improving jobs picture, will help spur several years of solid growth for the tech sector.

For Intel, more chips moving through its wafer-fabrication plants helped raise efficiency, leading to higher gross margin of 63.6% in the December quarter. This is a clear improvement from the 51% to 52% range in the prior two December quarters. We think Intel's decision to aggressively adopt advanced 300mm wafer plants and 90nm circuit-line widths is helping its performance in the present industry upturn, compared with the last cycle.

In 2000, the previous cycle's peak year, Intel's gross margin was 62.5%. Business slackened in 2001 and 2002, causing it to retreat to 49.2% and 49.8%, respectively. The figure improved to 56.7% in 2003 as business came back. Anticipating growth in 2004, Intel sees gross margin of 62%, plus or minus a few points. We at S&P are estimating 62.6%.

STEADY MODEL. We project strong growth in 2005 as well for the semiconductor industry and for Intel, and we believe the outfit's gross margin can improve to 64.7%, which would mark a higher cycle peak. We think this would vindicate Intel's strategy of being an early and large-scale adopter of advanced -- and expensive -- wafer-production technologies.

Another outfit that reported strong December-quarter results was Linear Technology (LLTC

; 4 STARS; or accumulate; $43), a large player in the high-end analog chip field. Sales rose 28% from the same quarter in 2002, and net income increased 32%. Linear described demand strength across all its many end markets and geographic territories. It's now beginning to see some orders from communications customers, whose business had been dormant since 2001.

Linear increased its quarterly cash dividend to 8 cents, from 6 cents, which we interpret as a sign of a healthy business. It has a relatively steady and profitable business model compared with most chipmakers. Linear tends not to need or want to make acquisitions. It does buy back its shares, but we believe the amount of buybacks that can be made without disrupting the markets isn't limitless.

RISING TIDE. The other option for using Linear's cash holdings of nearly $1.7 billion, which has grown to represent 89% of shareholder equity, is to pay dividends. Other prominent analog chipmakers that have recently initiated or increased their dividends include Analog Devices (ADI

; 5 STARS; $50), Maxim Integrated Products (MXIM

; 4 STARS; $55), and Microchip Technology (MCHP

; 5 STARS; $34).

Other signs of a rising tide for chips include upbeat remarks or results from major chip customers including Nokia (NOK), Cisco Systems (CSCO), Nortel (NT), and Juniper Networks (JNPR). Shares of IBM (IBM), both a maker and user of chips, rose after its earnings report described rising demand.

Although Texas Instruments (TXN

; 5 STARS; $34) doesn't report earnings until Jan. 26, its shares are trading at a 52-week high. We view Nokia's higher earnings guidance on Jan. 8 as a positive catalyst for TI, which makes digital signal processors and associated analog chips used in wireless phones and many other communications and computing markets.

ORDERLY TRANSITION. TI has been working on a long-term succession plan for some time. On Jan. 15, it announced that Richard Templeton, the chief operating officer, will step up to become president and CEO as of May 1, replacing Thomas Engibous, who will remain chairman. Back in June, 1996, Templeton replaced Engibous as head of the semiconductor operations when Engibous rose to lead TI following the sudden death of company leader Jerry Junkins.

Like Engibous, Templeton studied electrical engineering and is a career man with TI's semiconductor business. Together, they helped transform it into a chipmaker focused on digital signal processing by making a flurry of acquisitions and divestitures in the late 1990s. The sale in 2003 of the remaining shares of Micron Technology (MU) that TI had held since it sold memory-chip plants to Micron in 1998 might be considered the last chapter in the makeover process.

We view this CEO switch as an orderly transition and expect TI's strategy to remain in place. We think the incoming CEO's strategic challenges lie not so much in the present chip-industry cycle as in planning for the next cycle or two ahead.

TELLING RESULTS. A host of chipmakers are scheduled to report earnings over the next two weeks. On Tuesday Jan. 20, Advanced Micro Devices (AMD

; 3 STARS, or hold; $17) will deliver a report that we think may describe strong demand for flash memories used in portable electronics goods. Also that night, PMC-Sierra (PMCS

; 3 STARS; $24) and Applied Micro Circuits (AMCC

; 3 STARS; $9) will report and shed some light on the degree of strength in the markets for wireline communications chips.

The telecommunications-equipment industry has been a laggard in the fundamental recovery for the tech sector because of telcos' low capital spending. But the rising tide might eventually reach even this area, which would boost the fortunes of chipmakers serving the wireline markets.

Note: Tom Smith has no stock ownership or financial interest in any of the companies in his coverage area. He's a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion. Smith follows semiconductor stocks for Standard & Poor's Equity Research


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