The Road Ahead: Bottom-Fishing the Murky Depths of the Chip Sector

After semiconductor companies spent the past month churning out weak earnings reports and increasingly dire outlooks, there appears to be little to like about chips in 2001.

Friday's Coverage

Bottom-Fishing the Murky Depths of the Chip Sector

Previously

Internet Companies Trudge Into the Fog

For Banks, Hitting the Loan Books

Getting a Handle on the Wireless-Handset Slowdown

Why This Earnings Season Has Been So Brutal

Earnings Burned Investors, but the Tech Fire Remains

With No Catalyst, Stocks Rumbling and Stumbling Through February

Throughout January, chip companies said they were expecting semiconductor revenue to contract by anywhere from 15% to 30% in this quarter from the last. And considering the trend toward weaker guidance as the earnings season progressed, several analysts say there's still more room for chip stocks to fall.

Even so, the past few days have seen investors buying with both hands, believing that the bottom of the industry's supply-and-demand cycle is near, portending a bounceback for the beaten-down stocks. What's next for the chips?

Weakness

"We continue to be in an environment where demand is weak," says Mark Edelstone, an analyst at Morgan Stanley Dean Witter. "Expectations have come down quite a bit, but I don't think they have been lowered enough, on balance."

Semiconductor companies have been caught in a downdraft for more than six months. First, a glut of cell phones cut demand for chipmakers like Texas Instruments (TXN). Then in September, microprocessor manufacturers like Intel (INTC) begin suffering as personal computer demand waned. Growing inventories in supply channels across the telecommunications business then brought down communications chipmakers, like programmable logic device company Xilinx (XLNX).

As November data deteriorated, more chipmakers warned of earnings shortfalls. Edelstone says 55% of U.S. semiconductor companies' fourth-quarter earnings failed to measure up to the Wall Street consensus. Next time around will undoubtedly bring more disappointments, he says.

Salomon Smith Barney analyst Jonathan Joseph views the industry through a similar lens. "Expect a new wave of earnings warnings to come from our companies in the coming weeks as they realize the guidance given only last month was too optimistic," Joseph wrote this week in a research note.

Trend Spotting

Indeed, a look at trends in recent guidance suggests that events of the past month have soured chip execs on both the first quarter and the prospect for a second-half rebound.

The season started out innocently enough, even amid the widespread slowdown reports. Intel, for instance, on Jan. 16 told analysts revenue would decline by 15% in the first quarter but that personal computer demand would pick up later. The company this week reaffirmed that guidance for the first quarter, but declined to provide a 2001 projection.

Communications chipmaker Applied Micro Circuits (AMCC), which also announced earnings on Jan. 16, projected 20% revenue growth for its fourth quarter, ending March 31. The company said in January that it would show quarterly sequential growth of 10% to 15% after March. But by Feb. 5, it wasn't so certain: It issued a statement putting some question marks around its guidance, citing order cancellations and delays.

When Feb. 13 rolled around, chip equipmentmaker Applied Materials (AMAT) believed the next few months would turn out poorly. It predicted that revenue in the second quarter would decline as much as 30% and that earnings per share would drop by around 50% from the current quarter. The reason: declining orders and increasing cancellations. Beyond that, the company wouldn't say much, committing neither to the notion of a second-half rebound nor to a broader downturn.

Jeremy Lopez, a stock analyst at Morningstar, says one reason Applied Materials is painting such a dim picture of the near future is that it had a few extra weeks to learn its customers' spending plans. Some chip companies didn't have that luxury. For instance, makers of networking chips for telecommunications giant Cisco (CSCO) didn't get a full report until February, when Cisco made clear that its business was weakening.

"We already knew things were getting bad, and now we're pinning it down that it is really bad," Lopez says.

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