When the Chips Are Down


Slower growth -- that's the prospect for the semiconductor market in 2005, with something like 5% growth, compared to 28% last year and 18% in 2003. And that means a neutral outlook for semiconductor stocks broadly, says Amrit Tewary, who covers the chip industry as a senior industry analyst at Standard & Poor's. He sees a slowdown in growth of the end products that semiconductors go into, notably personal computers and wireless handsets.

Even so, Tewary does see some chip stocks worth buying. He has 5 STARS or strong buy opinions on Maxim Integrated Products (MXIM) and Linear Technology (LLTC), both of which turn out high-end analog chips. And he ranks as 4-STARS or buys Nvidia (NVDA), International Rectifier (IRF), and Microchip Technology (MCHP). At the other extreme, Tewary says S&P ranks shares of Micron Technology (MU) and Intersil (ISIL) 2 STARS, or sell.

Giants Intel (INTC) and Texas Instruments (TXN) warrant a hold ranking, Tewary reports. He notes that Intel, which is often at the leading edge of chip technology, is at work on a 65-nanometer process technology to manufacture a new generation of chips.

Tewary made these and other points in an investing chat presented Apr. 5 by BusinessWeek Online and Standard & Poor's on America Online. He answered questions from the audience and Jack Dierdorff of BW Online. Edited excerpts follow. AOL subscribers can find a full transcript at keyword: BWTalk.

Note: Amrit Tewary is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."

Q: Amrit, how have the chip stocks you cover been behaving since you were last with us, in early November?

A: The Philadelphia Semiconductor Index (SOXX) is down 5.4% year-to-date, while the S&P 500 is only down 2.5%. So semiconductor stocks on average have slightly underperformed the broader market. The reason for this underperformance, in our opinion, is twofold.

First, we see moderating growth for the industry in 2005 vs. 2004. For instance, we see growth of 5% for the global semiconductor industry in 2005, vs. actual growth of 28% last year and 18% in 2003. Secondly, we believe that growth for the major end markets -- specifically, PCs and wireless handsets -- is going to be slower this year than last. This plays into slightly less robust demand for chipmakers in general.

Q: Is anything new coming down the pike in chip technology that will ignite the industry anew?

A: There are a couple of things that chipmakers focus on. They constantly strive to improve manufacturing. For instance, Intel (INTC) is focusing on 65-nanometer process technology to manufacture a new generation of chips. This compares to the older, 90-nanometer process technology. Also, chipmakers generally devote a large proportion of their budget to product R&D.

Q: Do you have any strong buys among the chip stocks, in this environment?

A: We have a neutral stance on the industry as a whole. However, we do favor a couple of chip stocks. We like Maxim Integrated Products (MXIM) and Linear Technology (LLTC), both of which carry a 5-STARS (strong buy) opinion.

MXIM and LLTC are two high-end analog outfits that have similar businesses. We think the high-end analog business has more attractive long-term growth prospects than most other segments of the industry. MXIM and LLTC are well-run companies that have a diverse customer mix in numerous end markets. Both are highly profitable, with gross and net margins well above average. Lastly, we think both stocks are attractively priced.

Q: Do I keep Texas Instruments (TXN) and Intel?

A: We carry 3-STARS (hold) opinions on both TXN and INTC. We believe that these companies' technology leadership positions and scale-based advantages in R&D, manufacturing, and marketing should help them prosper over the long run. Although the stocks are down from a year ago, we think current valuation multiples are warranted, given our expectation for a moderation in industry growth in 2005. Also, we think valuations fairly reflect what we see as elevated macroeconomic risks and some lingering channel inventory concerns.

Q: What do you think about Nvidia (NVDA)?

A: We currently carry a 4-STARS (buy) opinion on Nvidia. We expect new-product momentum to enable share gains for the company in its core market for graphics-processor chips. Also, we believe recent agreements with Sony (SNE) and Intel have the potential to expand Nvidia's long-term market opportunity. We see sales growth of 19% in the current fiscal year and continued operating margin expansion due to a more favorable product mix and operating cost controls.

Q: Any other buys on the list of your stocks, Amrit? You've reported on the strong buys and now on Nvidia.

A: Yes. We have a 4-STARS (buy) opinion on International Rectifier (IRF) and Microchip Technology (MCHP). IRF is a manufacturer of power semiconductors that are used to enhance performance and efficiency of electrically powered products. We see robust sales growth for the year ending fiscal 2005 (June), driven by increased power management content in personal computers and other electronic devices, market share gains, and demand for new proprietary products.

We also have a buy opinion on MCHP. We are attracted by what we see as a superior business model vs. its peers, a below-average risk profile, and what we see as above-average financial flexibility. Based on our view of these competitive strengths, we expect MCHP to gain share in the 8-bit microcontroller market.

Q: What names would you avoid? Or sell?

A: I have a 2-STARS (sell) opinion on Micron Technology (MU). Average prices for the company's memory chips fell 15% during the second quarter of fiscal 2005. We expect prices to continue to deteriorate in the near term because of an imbalance of supply and demand, as Micron wraps up 300mm wafer production. In addition, we're concerned about the company's inventories, which we think are above optimal levels. The shares currently trade slightly above our 12-month target price of $10.

Also, we have a sell opinion on shares of Intersil (ISIL). We project sales to be down modestly in 2005, given our expectation of slower growth for the industry and market share losses for the company. Although Intersil has made efforts to reposition its product portfolio, we believe sales performance will continue to be hurt by above-average exposure to several slower-growth markets. In addition, although the company reduced inventory by about $3 million in the December quarter, we think inventory remains above optimal levels.

Q: Lucent (LU) isn't on your list but is a much-discussed tech stock -- what does S&P think about it?

A: S&P has a 3-STARS (hold) opinion on the stock. It closed at $2.53. We would hold the shares, trading below peers at 1.4 times our fiscal 2005 sales-per-share estimate. S&P forecasts that LU's total sales will grow only in the mid-single digits, well below peer levels, in fiscal 2005 and fiscal 2006.

Q: Is outsourcing anything of an issue in chips? Or foreign competition, as with Taiwan Semiconductor (TSM)?

A: Many smaller chipmakers typically outsource much of their production to foreign contract manufacturers. Chip production requires significant scale, and thus companies such as Intel and Texas Instruments have an edge. So it isn't surprising that many smaller companies outsource much of their production and focus more on the actual design of the chip.

Q: Do you see only modest growth for the end markets for products that chips go into? There are some forecasts for increased corporate spending on info tech.

A: We see slower growth for both consumers and enterprises in 2005. We believe that macroeconomic factors -- such as prices for oil and raw materials, the prospect of higher interest rates, and slow job growth -- will lead corporate and consumer chip customers to be less aggressive in their spending in 2005.


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