It's been a rough six months for semiconductor stocks as PC demand diminished and inventories built up -- just the opposite of what you want to see. The downdraft dragged even blue-chip names more than 50% off their highs.
Recent Daily Interviews
Economic Cycle Research Institute's
But buying semiconductor stocks is all about calling the bottom, and that's exactly what San Francisco investment bank
Thomas Weisel Partners
did on Monday.
Semiconductor senior research analyst Eric Ross upgraded the semiconductor equipment makers and PC-related chip companies saying that the worst is behind us. So far, it's worked in his favor. That call, which came one day before chip-equipment giant
released earnings, was followed by another investment bank on Wednesday. And so far this week, Applied Materials has added around 16%, and the
Philadelphia Stock Exchange Semiconductor Index
is up 14%.
In light of these moves, we thought we'd use today's Daily Interview as an opportunity to hear more about the case for the sector. (For a less sanguine view, check out
Monday's Daily Interview with
TSC: The semiconductor companies have been suffering as too much inventory and weak demand in the personal computer and communications sector chip away at sales and profits. Given the deterioration of fundamentals, why have some chips stocks actually gained recently?
In the last two weeks we've been to Asia and have done a lot of channel checks and we're hearing about an upswing in the end markets.
In particular, we're hearing that PCs are set for sequential growth beginning in the second quarter and that inventories are working off in that channel.
confirmed that this week, actually.
And in cell handsets we're hearing inventories are working off faster than expected, particularly in the entry-level market. Consumer electronics continues to be strong, and we have the least visibility into networking and enterprise equipment currently.
TSC: More specifically, this week, chip equipment maker Applied Materials gave a pretty negative outlook for the current quarter, estimating a 30% sales decline. Why have it and other chip companies soared afterwards?
We upgraded on Monday with the belief that the end markets were going to drive this group up, and the reason is that not that much capacity has been added this cycle. The reason that the semiconductor chip makers have slowed spending is that they built up inventories. So as end market demand increases, again, with lower added capacity, the inventories will burn off more quickly. This will drive a fast V-shaped recovery for equipment fundamentals in 2002.
Investors that are looking forward to 2002 know they can make much more on the upside in these stocks over the next two years then lose with the near-term potential downside in fundamentals.
TSC: But how do you know it's not too early to buy these stocks?
It is too early vs. what happened in past downturns. However past downturns were different. In the last downturn, in 1995, we added a lot of capacity and so we had to work that off -- it took though 1998. This time we know it's going to be a shorter downturn because we haven't added the capacity.
We know that the next two quarters are going to be very difficult for the equipment guys. We know that there's a lot of new technology spending that needs to be invested. It's really just a question of timing. We think this will come into focus in 2002 and thus it's back to the races with these stocks -- actually we are back to the races. Applied's at 50 bucks right now.
TSC: There has been debate about whether semiconductors were entering an inventory correction or a broader downtrend. At this point, is it clear which it is? When and how will investors know how to invest accordingly?
It's clear we are going through a slowdown in end market demand and that in part will be corrected by the
action. But we are seeing the first vestiges in many months of end market demand in PCs and handsets picking up. So yes, we've gone through a tough period, but investors know this and they try to look out six months or 12 months for the next trend. And the next trend is sequential growth in these products.
TSC: On the pricing front, there has been a steady decrease in DRAM, or dynamic access random memory, prices over recent months. Also, Intel and Advanced Micro Devices (AMD) - Get Advanced Micro Devices Inc. Report have been slashing microprocessors for PCs. How will this affect earnings or revenues as well as valuations going forward?
It'll affect revenues in the current quarter. We lowered our
numbers in response to lower DRAM pricing on Monday.
But I think investors are looking further out. We think we've seen the bottom of DRAM spot pricing and we've seen the bottom of microprocessor discounts that Intel and AMD are giving. Prices are off 75% over the last six months -- I don't think they'll come down more.
Thomas Weisel has not performed underwriting for any of the companies mentioned.