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Beaten Down Chip Stocks a Buy: Analyst

Chip firms are seen as a bellwether of the global economy, and shares of the major semiconductor manufacturers such as TSMC, UMC and ASE have fallen around 40 percent from their peaks earlier this year. The companies have been cutting their earnings forecasts as sales have slowed.

Technicians at work in the clean room of the Fab Equipment at a semiconductor company, Renesas Technology Corp. on June 17, 2004 in Ibaraki, Japan. Renesas is the first company to produce semiconductor products from 300mm wafer in the world.
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Technicians at work in the clean room of the Fab Equipment at a semiconductor company, Renesas Technology Corp. on June 17, 2004 in Ibaraki, Japan. Renesas is the first company to produce semiconductor products from 300mm wafer in the world.

But one analyst says the markets have already discounted the bleak growth and investors should now buy these stocks.

Steven Pelayo, regional head of technology research at HSBC based in Hong Kong, expects further earnings revisions in October, but says investors should buy the stocks before that.

"I understand there's going to be another numbers cut, but I do think that by the time we get to the third week of October, it will be 90 percent discounted," Pelayo told CNBC. "So I think the volatility over the next six weeks is really the opportunity to get involved in [these] stocks."

Back in 2008, shares of the world's largest contract chip maker, TSMC peaked about three to four months before analysts began cutting the company's earnings forecasts and the stock then hit bottom during the recession.

But according to Pelayo, shares had started to rise from the bottom even before the analysts had finished cutting their estimates.

"I think that when we get to October earnings season, we'll see four or five of my competitors start to upgrade as well," Pelayo said. "I think it's timely to be first to remind people that [you've] got to see more catalysts that are negative, taking advantage of those and make sure you're long going into October earnings."

The semiconductor industry has been prone to adding too much capacity during booms and then slashing during downturns. Industry leader TSMC, for example, forecasts it will spend a record $7.4 billion on equipment this year.

While Pelayo admits overcapacity is a concern, he says capacity utilization still remains high for the industry as a whole and for TSMC in particular.

"We're not seeing a scenario where you see companies going on a 50 percent utilization rate," he said. "85 percent is still widely profitable for this company, compared to the first quarter of 2009 where they were at risk of [losing] money."

Another concern is growing inventory levels, but Pelayo says TSMC's inventories are lighter than those at Nokia supply chain providers Texas Instruments and ST Microelectronics .

"When I do a survey of TSMC's customers, I come up with about 80 days of inventory," he said. "That's not the peak like we saw in 2008, but its very much a very high level...Texas Instruments and ST micro have 95 to 100 days of inventory when the average is 80."

Pelayo expects TSMC shares to rise 20 percent by the end of the year, UMC to rise 16.5 percent and ASE to rise 15 percent.

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