Another Bear Joins the Great Chip Debate Among Analysts

A fence-sitter in the semiconductor arena just jumped into the bear camp.

Merrill Lynch analyst Joe Osha downgraded four semiconductor stocks, telling investors that the 39% run-up in the Philadelphia Stock Exchange Semiconductor Index since April 4 was just a wee bit premature. His line of thinking: Industry fundamentals have not improved, and there's no proof yet that demand will pick up significantly in the next quarter. As a result, he cut near-term ratings on Intel(INTC), PMC-Sierra(PMCS), Applied Micro Circuits(AMCC) and Vitesse Semiconductor(VTSS), dropping all to neutral from accumulate.

"The recent sharp uptick in semiconductor stock price performance has investors asking whether we're close enough to the bottom to merit buying stocks," he wrote to investors this morning. "We think not."

With the note, Osha weighs in on the debate about the chip sector and whether it has seen its worst days. Since Salomon Smith Barney's Jonathan Joseph made a cautiously bullish call on Intel and other chipmakers 10 days ago, analysts have been jumping in with their opinions and investors have been jumping in with their money.

At that time, Osha took a measured approach: He disagreed that the PC sector was normalizing and entering a seasonal pattern. He said the bottom was close enough to buy some Intel now. "As an investment, we believe Intel makes sense here, despite our disagreement with the management's short-term view," Osha wrote to investors. "We expect the semiconductor business to bottom over the summer, and we believe we are close enough to that bottom to merit staying with our accumulate rating."

In today's note, however, Osha says that the rally could hurt investors because the stocks now face substantially more downside risk. Sure, the SOX, as the Philly Semi index is informally known, appears to have bottomed in the near term on April 4, but Osha said the industry fundamentals won't bottom for at least another quarter. That's three month's worth of trading with no improvement to the nuts and bolts of the semiconductor business.

Osha also said that the stocks could be overvalued on a price-to-earnings basis. "The picture on a price-to-earnings basis is more disconcerting -- on a P/E basis most of the group is actually closer to a peak valuation than a trough."

Wait until the summer for an industry recovery, the analyst told investors. The recovery will come, but it most certainly isn't at hand now. Nonetheless, investors have leapt into semiconductor stocks lately, feeding on positive comments from other analysts, most notably Salomon's Joseph.

Other analysts, like Hans Mosesmann at Prudential Securities, agreed with Joseph and added more fuel to last week's rally fire. Others dissented, splitting the analyst world into two camps, one calling for a bottom and upgrading companies and another reiterating low ratings and pointing at poor fundamentals. With today's move, Osha who had been a notable fence-sitter in this debate, finally picked a side. And he did it definitively.

"The frantic rush to 'be in front of it' is creating a situation in which investors have the potential to lose 40% between now and the real, fundamental bottom in the semiconductor business," he wrote. "We would add that there is no identifiable evidence that the semiconductor recovery is close at hand."

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