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Chip Stocks Still a Tough Read

The industry isn't a complete disaster, but expectations are being reined in.

For fans of pyrotechnics, chip stocks are putting on quite a show.

The recent spate of second-quarter earnings reports featured a series of spectacular meltdowns, including heavy-hitters like

Texas Instruments

(TXN) - Get Texas Instruments Incorporated Report

,

SanDisk

(SNDK)

and

Nvidia

(NVDA) - Get NVIDIA Corporation Report

, which released an ugly midquarter update.

TI fell as much as 18% the day after reporting its earnings, while SanDisk and Nvidia each crumbled more than 25% in a single session, sending shares to multi-year lows.

Wall Street's verdict seemed clear enough: Chip companies are damaged goods.

For all the fireworks, though, the chip industry is not the wholesale disaster on display within the automobile industry or the airline business -- at least not yet.

For every struggling chipmaker, there's another chip firm enjoying solid sales. And with another three months of business now accounted for, the dreaded macroeconomic slowdown has yet to truly leave its mark, making the sector particularly tricky to read for investors.

"It's really mixed out there," says one hedge fund manager in regards to semiconductor stocks. "You can choose to look at the glass as half-empty or half-full. There was something in this earnings season for everybody."

Indeed, the

Philadelphia Stock Exchange Semiconductor Sector Index

is almost exactly where it started before earnings season, underscoring the current uncertainty.

Of course, that means the SOX is still down 20% from its most recent peak in early May, and down more than a third from its 52-week high.

Inflation, unemployment and tight credit are all bad for demand, whether the demand is from a consumer buying a snazzy MP3 player or a business buying servers for its data center. While dampened demand is thus far only evident in disparate regional and product-related pockets, the ugly macroeconomic indicators are making everyone nervous.

The phrase "economic uncertainties," or some permutation of it, appeared in more than a dozen press releases by chip firms announcing their quarterly reports last month. Even chipmakers posting decent quarters felt compelled to cross their fingers and caution that things could soon go south.

"I get the sense that everybody is being cautious right now," says Friedman, Billings, Ramsey analyst Craig Berger.

Little by little, expectations for chip firms are being reined in to what some believe are more realistic levels.

The average analyst forecast for aggregate chip company revenue in the third quarter now calls for 5.6% growth, compared with an average of 6.4% growth prior to earnings season, and the historical rate of 8.3%, according to Citigroup.

"In general, we view these below-seasonal estimates as healthy, although not so conservative as to eliminate further downside potential," wrote Citigroup analyst Glen Yeung in a recent note to investors.

Yeung also noted that inventory among chipmakers crept up 3.13% in the second quarter, a trend he characterized as "somewhat disconcerting in light of a weakening macro environment," although he notes that the inventory build was below the normal seasonal growth rate of 3.98%.

Rising inventory levels are closely monitored by investors as they represent a key element governing the up-and-down dynamic in the highly cyclical chip industry.

It was no surprise then, that

TheStreet Recommends

TI's talk of growing internal chip stockpiles

was not well received by investors.

And the glut of flash memory chips that have flooded the market for more than a year shows no sign of clearing up anytime soon, even as companies like

Hynix Semiconductor

and SanDisk

reduce manufacturing capacity plans

.

Yet business looks healthy enough for some chipmakers. Microprocessor maker

Intel

(INTC) - Get Intel Corporation (INTC) Report

grew its bottom line 23% year-over-year, while

Broadcom

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,

Altera

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and

Atheros

(ATHR)

each posted double-digit percentage growth in second-quarter sales.

The chip world is currently split between "haves and have-nots," notes Berger, of Friedman, Billings, Ramsey.

The breakdown between the two classes of chipmakers at the end of the second quarter remained more or less the same as in previous months.

The PC market shows no signs of cooling off as consumers in emerging markets continue to snap up notebook computers and take a shine to the new class of ultra-mobile PCs such as the

Asus

Eee PC.

And networking and infrastructure components, including chips used in digital set-top boxes that are used with TVs, are selling briskly.

With so much gloom permeating the broader market, though, investors can't help but worry how long these pockets of strength will remain immune. Worries of a

post-Olympic slowdown in China

are already surfacing, potentially putting the recent surge of networking and infrastructure spending in jeopardy. And calling an imminent falloff in PC demand remains a favorite Wall Street pastime.

Several chip giants fell hard in the second quarter. The fear is that many more have yet to stumble.