Chips Hit Rocky Road

Semiconductor makers aren't inspiring skittish investors.
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At a time when the

Dow

has soared to new highs, chip stocks are stuck on the runway.

Many chip firms posted record revenue for the recently ended third quarter. But skittish investors have steered clear of semiconductor stocks, fearing that the next downturn could be around the corner in the famously cyclical industry.

The raft of earnings reports released over the past few weeks did little to allay those fears.

About 45% of chip firms delivered fourth-quarter guidance that was below consensus estimates, according to Wedbush Morgan Securities analyst Craig Berger. That's a bad sign, because the fourth quarter is supposed to be the strongest for many semiconductor firms.

Becker Capital Management's Pat Becker Jr. says it's unclear whether the chip industry is entering a downturn, but regardless, he believes the industry is set up for anemic performance over the next couple of quarters.

"We're going to have sequential declines here in the fourth quarter, then you go into the first quarter, which is a seasonally weak quarter," says Becker.

Throw in the lingering concerns about rising chip stockpiles and a spate of less-than-reassuring data about consumer confidence, and many investors believe their money is better spent elsewhere.

Chips are very economically sensitive, so going into an economic slowdown with some indications of rising silicon inventory does not strike Putnam Global Equity Fund's Shigeki Makino as the best time to pick up semi stocks.

"If it had been the case that everybody is being really strict on

manufacturing capacity additions and were lean on inventory, that would be a different story," says Makino, whose firm does not currently have any semiconductor positions besides a longer-term bet on South Korea's

Hynix Semiconductor

.

The gloom is reflected in the Philadelphia Stock Exchange Semiconductor Sector Index, which has been range-bound for two months, and is down about 17% since setting 2006 highs in late January.

It's hard to find a segment of the semiconductor industry that's not under a cloud.

Microprocessors continue to be mired in a price war between

Intel

(INTC) - Get Report

and

Advanced Micro Devices

(AMD) - Get Report

that has taken a toll on each company's profit margins. And the delay of

Microsoft's

(MSFT) - Get Report

Vista operating season until 2007 has many people forecasting lackluster PC sales this holiday season.

NAND flash-memory chips are experiencing plummeting average selling prices --

down 60% year over year for

SanDisk

(SNDK)

-- amid fears that a boatload of forthcoming manufacturing capacity will outrun demand.

But the semiconductor industry's biggest woe involves its most reliable growth engine for the past couple of years: cell phones.

There were scattered signs of trouble in the wireless sector throughout the summer. But when

Texas Instruments

(TXN) - Get Report

, the world's No.1 maker of cell-phone chips, confessed that

orders were down sharply during its earnings report in October, the wireless "glass" officially became half-empty.

National Semiconductor's

(NSM)

sales warning earlier this week, which it

blamed on slower-than-expected cell-phone sales, underscored the mentality.

But there's some debate about the exact nature of the trouble afflicting the cell-phone market. TI said its order slowdown owed to a temporary pause in demand for high-end handsets, which it stressed was different than the inventory buildup of high-performance analog chips in the sales channel that's affecting other chipmakers.

Skyworks

(SWKS) - Get Report

, by contrast,

reported strong sales of power management chips and front-end modules for high-end 3G cell phones in the most recently completed quarter, although CEO David Aldrich characterized the overall wireless phone market as "choppy."

And despite the various concerns coloring the cell-phone sector, industry analysts say they don't expect any decline in overall handset demand this year.

"It goes to show that this has not been an absolute falloff in wireless demand, it's just been a mix-shift, and people have had to adjust their expectations for what kind of products are going to be sold," says Stifel Nicolaus' Cody Acree.

With most of the negativity now priced into wireless-chip stocks, Acree believes wireless could provide a growth catalyst for chip stocks if consumer demand holds up during the holiday season.

Likewise, he believes certain beat-up semi players like Intel,

Marvell Technology

(MRVL) - Get Report

and

STMicroelectronics

(STM) - Get Report

carry such conservative financial estimates that they could see significant upside from stronger-than-expected holiday sales and the subsequent shipments needed to restock customer inventories. Stifel Nicolaus makes a market in Intel and Marvel securities and has provided Intel with non-investment banking services in the past 12 months.

But for some investors, the best tack to take with chip stocks right now is to find companies that can ride out tough times on the strength of their own products.

"Is there a company out there that's going to take market share from their competitors and can come through this downturn relatively unscathed?" asks Becker. He believes

Lattice Semiconductor

(LSCC) - Get Report

fits the bill.

But he points out, such companies are a rarity. Indeed, Lattice is the sole chip stock in his firm's portfolio.