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Editor's Note: This column appeared exclusively on RealMoney on Monday, March 22, and is running now as a special bonus for TSC readers. For a free trial subscription to RealMoney and other semiconductor coverage, click here.

I've been as surprised as anyone at how far the chip stocks have corrected this year. I won't try to explain it after the fact, because I didn't see it coming -- and I should have.

However, after checking in with my old industry contacts, I remain very enthusiastic about this industry's upcycle. Book-to-bill ratios are still strong, over 1.0. Pricing is firmer and order lead times are lengthening. Industry excess capacity has been absorbed, and managements are preparing for a sequentially stronger second quarter and second half.

Eventual Recovery in Corporate Demand

In 2003, when semiconductor industry sales grew 18%, consumer electronics drove most of the growth, as corporate IT spending never really got going. So it's no wonder that this year's first quarter has seen seasonality in computer sales and some inventory backup. Corporate demand for computers still isn't recovering much, but it will eventually, and that will help drive chip sales higher.

Meanwhile, I'm keeping my positions in leading chip stocks, including


(INTC) - Get Intel Corporation Report


Applied Materials

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(TER) - Get Teradyne, Inc. Report


Micron Technology

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(AVX) - Get AVX Corporation Report


I'm getting more confirmation that now is the time in the cycle for commodity components to do better. Prices are firmer for DRAMs and capacitors. Also, worldwide chip capacity is getting tighter, and longer lead times are increasing the urgency for more production and test equipment.

Intel has retraced nearly half of its $20 price rise since the October 2002 low of around $14. Now, at $26.50, it's still up 90%. I'm still looking to make a three- to fivefold gain eventually over this cycle. So far I have about a double in Intel, supported by an earnings forecast of more than $2 a share in 2005.

A concern is growing on Wall Street that the cycle's best earnings growth rate is now past and that the chip sector will languish from here. I couldn't disagree more. Historically, these stocks have done well early in economic expansions, then have underperformed in midcycle while earnings catch up, then outperform as earnings, helped by higher chip pricing, exceed expectations.

An Interesting Way to Play

While waiting for history to repeat itself, I've been examining the chip distribution industry. I like what I see. It's been a while since these stocks have gotten the research coverage they used to, so I've been looking at


(AVT) - Get Avnet, Inc. Report

, the industry leader with annual revenue of nearly $10 billion.

Not too long ago, the short-sellers were circling Avnet on stories of possible bankruptcy. The company wasn't profitable, it had a bond issue coming due, and everyone was sure the chip industry was headed further south. Since then, the company's profits have returned, the stock has more than doubled, it refinanced its bond debt at very favorable terms, and interest in the company is perking up.

Avnet has two distribution businesses: chips and computers. The chip side (about 60% of total revenue) is strong: Its book-to-bill ratio is 1.2. The computer business (about 40% of total revenue) is so-so, waiting for corporate IT spending to pick up.

Even without all cylinders firing, Avnet's earnings are likely to jump to about 25 cents a share in the March quarter, from only 7 cents in December, and to hit 30 cents in the June quarter. That would make annualized earnings equal to the Street's full-year fiscal 2005 estimate of $1.20 per share, which provides for no further upside. In reality, growth of another 20% to 30% is more likely. In addition, management has taken a half-billion dollars out of selling, general and administrative expenses and has sharply lowered interest expense.

Like other distributors, Avnet has almost no inventory risk, because unsold products can be returned to suppliers. In addition, inventory is protected against manufacturers' price cuts after it's in Avnet's hands.

Avnet's backlog has been rising recently, and its business scheduled for shipment beyond 30 days is up to more than 50% of its total volume, compared with below 30% a few quarters ago. This makes it easier to forecast earnings and to plan inventory, which is up somewhat this quarter as lead times from suppliers lengthen.

Avnet also has a big play in China, with three warehouses serving 23 cities. By this summer, Avnet's sales in China will reach $1 billion, or 10% of worldwide sales, making the company the largest Western distributor there.

The company's stock has pulled back by almost 20% in the chip correction and now sells for only about 15 times fiscal year 2005 (June) earnings, which I see hitting $1.50 a share, not the $1.20 consensus. It's not a bad way to play the next leg up in the chip sector -- without the specific product and manufacturing risk of the chipmakers themselves.

At time of publication, Kurlak was long Intel, Applied Materials, Micron, AVX, Broadcom, and Teradyne, although holdings can change at any time.

Tom Kurlak is the former semiconductor industry analyst for Merrill Lynch, now retired. For 19 consecutive years, Kurlak was on the Institutional Investor All-Star Team until his departure for Tiger Management in February 1999. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Although he cannot answer questions about individual securities, Kurlak appreciates your feedback and invites you to send your comments to