Market Insider

Chipmakers Signaling Bottom as Stocks Rebound

Several chipmakers this quarter turned in tepid earnings reports and weak outlooks, but some strategists say the industry may be nearing a bottom and there's still further room for upside in the stocks.

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Many chip stocks have been rallying as the economy has improved and investors put new money to work in the new year.

But the chip industry has been plagued by problems. Flooding in Thailand last year created a hard-disk drives shortage, forcing PC manufacturers to decrease their production and in turn, causing them to cut back on demand for semiconductors.

Adding to woes, chip demand also suffered in the latter part of 2011 due to the volatile economic environment.

Earnings estimates for the industry were slashed by 30 percent and the sectors' stocks lagged the S&P 500 by 12 percent last year.

Investors though have been bargain hunting in the group, driving some names sharply higher. The Philadelphia semiconductor index, SOX has gained nearly 15 percent year-to-date.

“The positive stock momentum will likely continue a bit longer, but in the next few months, investors will see that the growth trajectory off of the bottom will be a bit more muted than hoped," said CJ Muse, analyst at Barclays Capital. "And at that point, they’ll have to focus more on stock selection and relative value."

Despite the immediate challenges, many industry experts believe the slowdown in semiconductor sales should turnaround in the second half of 2012, as hard disk drive production picks up.

“My sense is that most of the inventory issues and hard disk drive issues as you enter the second quarter will be over,” said Hans Mosesmann, senior semiconductor analyst at Raymond James.

“We’re either close to the bottom or right at the bottom…I’m willing to hold some of these semiconductor stocks for a year. There’s a possibility of a nice snapback after we go through this inventory correction,” he said.

Earlier this week, Nvidia cut its quarterly sales outlookover hard-disk drive shortages, prompting JMP Securities to downgrade the graphics chipmaker’s rating to “underperform.” In addition, Sandisk late Wednesday warned that its revenue in the first half of 2012 would be hurt by weaker demandfor some mobile device manufacturers.

Not even industry giant Intel was spared from the storm as the Dow component said it expects shortage of hard disk drives to impact business in the first quarter. Intel was downgraded to “hold” from “buy” at Kaufman Brothers and to “neutral” from “buy” at Sterne Agee. Meanwhile, Intel shares were trading at a four-year high on Thursday.

Barclays' Muse said stocks, such as Qualcomm , Broadcom and Teradyne, are poised for further upside as smartphone sales will continue to grow in 2012. In addition, he favors Micron , based on price recovery in DRAM chips (dynamic random access memory) in the second quarter.

Meanwhile, Muse noted that the analog sector is "nearing the end of its course."

“Valuations there look peaky relative to the rest of the group. Unless there’s a meaningful recovery in the second half of 2012, many of these stocks are now primed, within the semiconductor world, to underperform," he said.

Additionally, strategists also expect to see increased sales of PCs and tablets, while smartphones will continue to be in high demand thanks to low-end 3G smartphones in emerging markets and continued replacement cycle of existing phones by smartphones around the world.

“While things are somewhat off in the first quarter…you’re getting to the point where you should see a rebound in chip orders,” said Andy Ng, analyst at MorningStar. “[Earnings] outlooks have been mixed, but a lot of these stocks have been going up because business conditions are expected to gradually improve.”

Morningstar has four-star ratings on names such as Texas Instruments , Analog Devices , Skyworks , ATMI and Marvell . In addition, the firm has a five-star rating on Applied Materials .

In addition, Ng noted that when M&A activity in the chip industry starts to pick up, companies such as Ultratech and Rudolph Technologies are possible acquisition candidates.

Mosesmann favors stocks such as LSI , Nvidia and Altera .

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