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Merrill Ups Estimates for Chips, but SOX Slips

It expects chip-industry revenue to rise 23% in 2004 vs. 18% previously. Still, the sector lags Tuesday.

Upping its forecast for the chip industry, Merrill Lynch said Tuesday the silicon rebound has gotten underway sooner, and sales are growing faster, than it initially anticipated.

The brokerage giant said it now expects semiconductor industry revenue to grow 23% in 2004 to $203.6 billion, up from an earlier estimate of 18% growth. It based the new outlook on favorable trends in end demand, pricing and inventory levels.

The flip side of the raised outlook for 2004 is that Merrill now expects the growth rate to slow down late next year. "Our model suggests that growth rates will remain buoyant until September 2004, when difficult year-on-year comparisons bring the rate down from the current 20% to 30% range to midteens," analyst Joe Osha said in a note.

In 2005, semiconductor sales should grow only 16% to around $236.3 billion, Merrill predicts, instead of 21% as previously expected.

Other investors and analysts have likewise argued that chips are likely to enjoy at least a

couple more quarters of decent growth, but that momentum could slow next fall if the pace of consumer spending abates.

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"The implication for semiconductor stock-price performance is positive for the next several quarters," Osha wrote. "Especially given the upward bias to revenue and earnings estimates that we've written about, we expect positive revenue growth momentum to drive further stock-price performance."

On Tuesday, however, the Philadelphia Stock Exchange Semiconductor Index dipped 0.5% to 479.96. Still, the index has risen about 67% year to date.

Osha believes that as chip demand accelerates, semiconductor manufacturing plants will need to add 10% more capacity in 2004, followed by another 11% capacity increase in 2005.

That should help fuel growth in semiconductor capital spending to 30% in 2004, up from a prior estimate of 27%, and 22% in 2005, down from an estimate of 33%.

The 2005 outlook, by the way, "is quite a bit less than the standard growth rate for the second year of an upcycle," Osha noted. To put Merrill's current outlook in perspective, the firm notes that spending in the second year of an upturn shot up 73% in 2000, following 13% growth in 1999. Capital spending surged 48% in 1994, up from 27% in 1993.

The Merrill projections on chip growth are a tad sunnier than those from some other sources, including the industry's leading trade group. But that could change, since such forecasts are subject to frequent revisions, and the trend among market research groups and banks has been to tilt their outlooks upward.

In early November, the Semiconductor Industry Association, the leading trade group, predicted chip-sales growth of just under 20% in 2004, with growth quickly slowing to a mere 5.8% in 2005.