Demand Jitters Slug Semiconductor Stocks

Chip names fall as Cisco calls into question the robustness of future IT spending.
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Updated from 1:01 p.m. EDT

Chip stocks swooned Wednesday as a

revenue warning from

National Semiconductor

(NSM)

and a

lackluster demand outlook from

Cisco

(CSCO) - Get Report

after the bell Tuesday heightened concerns that the third quarter is on pace to be more sluggish than expected.

The Philadelphia Stock Exchange Semiconductor Index was recently off 6.4% to 368, while National Semi tumbled $2.37, or 15.1%, to $13.33 and

Intel

(INTC) - Get Report

was down 65 cents, or 2.9%, to $21.89.

Communications chipmakers, hurt by Cisco's report, also were reeling:

Cypress

(CY) - Get Report

sank 68 cents, or 6.5%, to $9.84 and

Integrated Device Technology

(IDTI) - Get Report

was down 85 cents, or 7.7%, to $10.15.

Broadcom

(BRCM)

sank $3.49, or 10.6%, to $29.39.

The unwelcome news from Cisco and National Semi, combined with last week's weak monthly job numbers that could

foretell further weakening of consumer demand, paint a troubling picture for investors already concerned about inventory build-ups across the semiconductor spectrum, from Intel to Broadcom to

Texas Instruments

(TXN) - Get Report

.

If demand weakens further, chipmakers may be hard-pressed to clear out those inventories.

"There have been concerns about the housing market and that consumer spending has been feeling

a downturn. Now Cisco is saying IT spending may be less robust than people had thought it would be. So, it doesn't look good as far as the corporate side taking the baton from the consumer," said Bobby Burleson, an analyst at JB Hanauer & Co. Before Cisco's outlook, he pointed out, "We haven't heard people questioning whether or not IT spending was going to be worse than people thought. So that's introducing the demand problem, plus Cisco's inventories grew."

On the other hand, some said today's selloff was harsher than warranted by business trends. "I think

the market's down so much because people are remembering the days of 2000. Back then when you had an inventory problem, it became a four- to five-quarter event with earnings coming down over a long period of time. I think people are probably overreacting today," said Piper Jaffray's Tore Svanberg.

He pointed out that Cisco's raw materials inventory -- which includes semiconductors -- was up 4% sequentially, lower than the company's growth rate. "That's why we think the inventory increase we have seen in semiconductor components for the last two quarters is not dramatic. But every time people see an inventory correction they get spooked."

Svanberg said the inventory build noted by National Semi "could very well be eaten up in a 90-day period, which would mean a resumption of growth for National in the November quarter."

Depending on how demand shapes up, a slowdown could wash over to semiconductor equipment suppliers, which also fell in sympathy.

Applied Materials

(AMAT) - Get Report

was down 77 cents, or 4.6%, to $16.13, while

Novellus

(NVLS)

fell $1.30, or 5.2%, to $23.93.

KLA-Tencor

(KLAC) - Get Report

was off $2.03, or 5.3%, to $36.36.

"They're counting on their customers wanting to put more equipment in place. But those capex budgets could come down if they're in an inventory overhang situation longer than expected," Burleson noted.

Burleson, who downgraded National Semi to a market perform rating in early July, said he wasn't surprised by the shortfall since rival

Fairchild Semiconductor

(FCS)

had already reported that some distributors had canceled orders at the last minute.

But he and other analysts noted that National Semi may have initially misjudged guidance, at least in part because of its potentially confusing accounting policies, rather than because it was over-optimistic on the demand outlook.

National Semi recognizes sales of chips into the distribution channel, unlike most chipmakers, which recognize sales when the products are in the hands of the actual hardware manufacturer. Most market watchers believe the latter policy gives chipmakers better visibility, as they're dealing with PC vendors or handset makers that keep close tabs on end-market demand. Distributors, which are once removed from end customers, may find it slightly tougher to judge demand correctly and may be more apt to wind up with inventory builds.

Investors will look for further clues on the shape of demand when

Dell

(DELL) - Get Report

reports Thursday. But the massive PC and server maker isn't necessarily representative of the broader market, since at least some of its growth is based on ongoing market share gains at the expense of competitors like

Hewlett-Packard

(HPQ) - Get Report

and

Sun Microsystems

(SUNW) - Get Report

.