The Mean Season: Chip Biz Will Crumble in the Second Quarter

Some days it seems that the great chip debate -- whether the semiconductor sector will recover in the year's second half -- will continue into 2002. But one thing is certain: Chips will crumble in the second quarter.

Call it a return to a seasonal trend, an extended inventory correction, a slowdown in consumer demand or even a recession. And the cause of each company's struggle to bring in more revenue differs slightly depending on its end market, from personal computers to communications. In some areas, pricing pressure is becoming an issue. But what almost every major chipmaker indicated when releasing first-quarter results is that business is as poor as it has ever been.

What that might mean for the year isn't clear. Some say it indicates that the chip industry is bottoming. Intel (INTC Quote - Cramer on INTC - Stock Picks) says that's the case when it comes to the PC market. So does Advanced Micro Devices (AMD Quote - Cramer on AMD - Stock Picks). Communications-chip maker Applied Micro Circuits (AMCC Quote - Cramer on AMCC - Stock Picks) says maybe, maybe not.

One Certain Thing

But in each case, executives agree revenue and earnings will slide in the second quarter compared with the already weak first quarter. And that decrease, some on Wall Street say, could make for a turbulent environment for these companies' stocks. The risk, Credit Suisse First Boston argued in a research note this week, is that just because business is pretty bad doesn't mean it can't get worse. There have been prolonged downturns before, in 1985 and 1991, the firm warned.

It's this possibility that investors need to keep in mind as they buy the stocks now, trying to get ahead of a turnaround. Historically, semi stocks have run up before supply and demand balance out. Investors clearly believe they're on the cusp of this. Since the beginning of the year, the Philadelphia Stock Exchange Semiconductor Index has climbed 12%, after losing about 18% in 2000. The biggest gains came in April, when the SOX rose 22%.

The stocks climbed even as chip companies gave their grim second-quarter outlooks. Among microprocessor makers, Intel says that second-quarter revenue will come in anywhere from 7% down to 1% up from the first quarter. After a strong first quarter in which it gained market share from the formidable Intel, Advanced Micro Devices sees revenue slipping as much as 10% in the second quarter from the first.

Among communications companies, names like Broadcom (BRCM Quote - Cramer on BRCM - Stock Picks) and PMC-Sierra (PMCS Quote - Cramer on PMCS - Stock Picks) that feed companies like Nortel (NT Quote - Cramer on NT - Stock Picks) and Cisco (CSCO Quote - Cramer on CSCO - Stock Picks) can hardly express how weak they think the second quarter will be. And others, like maker of programmable logic devices for communications companies Altera (ALTR Quote - Cramer on ALTR - Stock Picks) and cell-phone chipmaker Texas Instruments (TXN Quote - Cramer on TXN - Stock Picks), also are looking at a 20% drop in the second quarter.

No Help

Diversification doesn't necessarily help either. French-Italian chipmaker ST Microelectronics (STM Quote - Cramer on STM - Stock Picks), which sells into many markets including the consumer, communications and computer peripheral sectors, expects the June quarter to be a tough one.

Alain Dutheil, ST Microelectronics' vice president for strategic planning, says that the company expects June quarter revenue to fall to $1.65 billion to $1.8 billion from the $1.9 billion it booked in the March quarter. "The second quarter is going to be difficult," Dutheil said. "Our visibility is not good."

And now, Dutheil worries about capital equipment spending during the fourth and first quarters increasing supply during the next two quarters, which could drag on prices when demand fails to pick up at the same pace. Already, ST Microelectronics has seen pricing pressure on its commodity type products, he says.

So pricing is yet another issue that will play out in the second quarter industrywide. This week, Intel cut prices again on its Pentium 4 chips, which are now all priced below $350, as much as 50% lower. (Intel has said these cuts are factored into its revenue estimates.) Prices on memory, including DRAM, or dynamic random access memory, and flash, also are down. That affects companies like Micron Technology (MU Quote - Cramer on MU - Stock Picks), which garners much of its revenue from DRAM and other makers of flash, like AMD.

It's not clear how much falling prices will hit earnings in 2001. But for the second quarter, it's yet another point executives can agree doesn't look good.