By Amrit Tewary Semiconductors have historically been a highly cyclical growth industry. Although no two chip cycles have been exactly alike, a classic four-year cycle has two years of strong growth, near 20% annually, one down or flat year, and one slow-growth year. The timing of booms and busts is influenced by both fluctuations in demand and changes in the general pace of economic growth.
Meanwhile, supply is affected by a tendency to stop building semiconductor factories, or "fabs," during a downturn -- as overcapacity hurts chip pricing -- and to build a lot of fabs when an upturn begins -- as undercapacity evolves and prices begin to improve. It takes two years to build a fab, thus creating the two fat years of the upturn, when demand exceeds supply and average prices for chips remain strong until the new generation of fabs is turned on.
We at Standard & Poor's Equity Research believe that the peak year for global chip sales in the last cycle was in 2000, when sales hit $204.4 billion. The upswing that ended in 2000 was unusually strong, driven, in part, by strong pricing for communications chips used in building the infrastructure for the Internet, in our opinion. The cycle bottom in the second half of 2001 represented an unusually deep decline in revenues and capacity utilization, which we think set the stage for a long, slow recovery.
CONSUMER WORRIES. In 2004 semiconductor revenues rose 28%, to $213 billion, surpassing the level reached in 2000. We believe sales will continue to grow this year, although at a much slower pace. We estimate sales will climb 5% in 2005, to roughly $224 billion, before possibly declining in 2006. Growth should slow this year because of the lingering impact of the recent midcycle inventory correction that began in the second half of 2004, in our view. Slower expansion of the economy in general, as well as for the major electronics end markets, will also cut back semiconductor growth this year, we believe.
In addition, we see a risk of dampening consumer spending in 2005 as a result of relatively high energy prices, slow job growth, and rising interest rates. More than half of all the chips sold worldwide each year end up in consumer products, according to the Semiconductor Industry Assn. (SIA). Consumers now spend about 30% of their discretionary income on electronics, most of which contain large amounts of semiconductors. Therefore, slower growth in consumer incomes and spending could have an impact on demand for chips, we believe.
Despite the industry's cycles, underlying demand for semiconductors tends to be persistent and strong, in our opinion, as modern society continues to find new uses for ever-smaller and more powerful chips. Industry sales rose at a 16% compound annual growth rate from 1975 to 2000, according to the SIA.
SUNNINESS IN CHECK. The trade group maintains that the industry's large size makes it unlikely that growth rates in the mid-teens will be sustainable over the long term. The SIA expects the semiconductor industry to grow more in line with its major markets (PCs, handsets) -- in the 8% to 10% range annually.
Although this projected rate is less than those in the semiconductor industry's heyday, we believe it would still be considered high compared with the pace of growth for most large industries. Since late 2002, the SIA forecasts have been made with this assumed long-term "speed limit" on growth in mind, partly, we believe, to respond to criticism that its past forecasts have been too optimistic.
We think that quality chip companies with high-end products, diversified end markets, and financial flexibility will outperform in this market environment. We have 5-STARS, or strong buy opinions, on Linear Technology (LLTC
; recent price: $36) and Maxim Integrated Products (MXIM
; $38), two high-end analog chip outfits that we believe have excellent prospects for long-term growth and the resources and management knowhow to remain profitable through the most difficult market environments.
BIG UPS AND DOWNS. A word of warning to the unwary investor: Chip stocks tend to be extremely volatile. Share prices for semiconductor companies typically move sharply in anticipation of upturns and downturns. As investors monitor the industry's vital signs for changes in the pace or direction of growth, we believe their reactions to news often contribute to short-term volatility in the share prices.
Many chipmakers often trade at high valuation levels compared with the overall market, which we also think contributes to price volatility. We have observed many days when share prices of all of the semiconductor stocks that we cover moved by several percentage points, and we saw at least one day where all the issues moved at least 10% (based, in our opinion, on a major change in Federal Reserve policy). In short, a chipmaker's price movements can be sudden and dramatic.
In the U.S.
As of Mar. 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations, and 12.5% with sell recommendations.
As of Mar. 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations, and 20.3% with sell recommendations.
As of Mar. 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations, and 17.7% with sell recommendations.
As of Mar. 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations, and 13.8% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index, and in Asia the S&P Asia 50 Index.
For All Regions:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
Additional information is available upon request.
This report has been prepared and issued by Standard & Poor's and/or one of its affiliates. In the United States, research reports are prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"). In the United States, research reports are issued by Standard & Poor's ("S&P"), in the United Kingdom by Standard & Poor's LLC ("S&P LLC"), which is authorized and regulated by the Financial Services Authority; in Hong Kong by Standard & Poor's LLC, which is regulated by the Hong Kong Securities Futures Commission, in Singapore by Standard & Poor's LLC, which is regulated by the Monetary Authority of Singapore; in Japan by Standard & Poor's LLC, which is regulated by the Kanto Financial Bureau; and in Sweden by Standard & Poor's AB ("S&P AB").
The research and analytical services performed by SPIAS, S&P LLC, and S&P AB are each conducted separately from any other analytical activity of Standard & Poor's.
S&P and/or one of its affiliates has performed services for and received compensation from LLTC during the past 12 months.
MXIM is not a customer of S&P or its affiliates.
This material is based upon information that we consider to be reliable, but neither S&P nor its affiliates warrant its completeness, accuracy, or adequacy and it should not be relied upon as such. With respect to reports issued by S&P LLC-Japan and in the case of inconsistencies between the English and Japanese version of a report, the English version prevails. Neither S&P LLC nor S&P guarantees the accuracy of the translation. Assumptions, opinions, and estimates constitute our judgment as of the date of this material and are subject to change without notice. Neither S&P nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results. Analyst Tewary follows semiconductor stocks for Standard & Poor's Equity Research