Five Ways to Play a Rebound in Semiconductor Stocks

What a difference a year makes - or, for that matter, even a mere quarter.

Back in September 2009, most analysts were anticipating a surge in 2010 semiconductor sales that would reflect the upcoming economic recovery. After all, semiconductors are used in virtually every device consumers deem essential these days - from smart phones and notebook computers to coffee makers and gaming consoles. Yet the industry had been mired in a three-year slump that saw global semiconductor sales plunge 9.6% in 2009 alone.

By April of this year, the numbers seemed to confirm those expectations. First-quarter worldwide sales had soared 58.3% to $69.2 billion from the prior year quarter's $43.7 billion, according to the Semiconductor Industry Association (SIA), the sector's leading U.S. trade group.

The individual leaders in the industry - Intel Corp. (Nasdaq: INTC), Texas Instruments Inc. (NYSE: TXN) and LSI Corp. (NYSE: LSI) - reported sharply higher quarter-over-quarter results. In fact, Intel broke its annual sales annual sales record.

Stock prices also responded as forecast. After dipping to $18.50 in early November, Intel marched to a new high of $24.22 on April 15, 2010. TXN climbed from an October low of $22.49 to an April high of $27.16. And Advanced Micro Devices Inc. (NYSE: AMD) went from $4.60 a share to $10.16.

However, the broad market's stumble from early April highs to early June lows carried the chip stocks with it. And despite a decent broad market bounce since the major indexes hit their latest lows on July 2, the chip stocks have continued to languish - and the reasons have become increasingly clear the past couple of weeks.

Now, the SIA says that while semiconductor sales continue to rise, the pace has slowed somewhat and expectations for the months ahead are a bit more muted.

Specifically, global chip sales for the second quarter rose 7.1% from the first quarter to $74.8 billion, and sales for the first half of 2010 were up 50.4% from 2009's depressed levels. But sales of $24.8 billion in June were just 0.5% higher than May's numbers.

"We expect that sequential growth rates will moderate in the coming months," said SIA President Brian Toohey in explaining why the group's mid-year forecast for annual 2010 sales growth had been revised downward to 28.4% year-over-year.

That was borne out by the SIA's July sales numbers, which showed an increase of just 1.2% over June, with the year-over-year growth rate slipping to just 46.7% from June's 50.4%. (Note: The SIA calculates its growth percentages based on a three-month moving average.)

Toohey gave a preview of more recent sales reports from some of the individual chipmakers, but stuck to the SIA's earlier growth projection.

"Although recent public statements from a number of major manufacturers have emphasized limited visibility for the near-term, we continue to expect that industry growth for 2010 will be in line with our mid-year forecast of 28.4%," he said.

Indeed, Texas Instruments and National Semiconductor Corp. (NYSE: NSM) reported quarterly numbers that, while within the range of earlier projections, were disappointing compared to forecasts.

NSM said its quarterly revenue was $412 million, less than the $415 million expected by analysts, though the earnings of $89 million, or 35 cents a share, were a little above the 34-cent average forecast, as compiled by Thomson Reuters I/B/E/S. The report's most disappointing element was a prediction that "sales in the current quarter could fall as much as 5% from the three months ended in August" - a statistic based on indications from NSM's major customers that they intended to reduce inventories rather than buying new product.

The NSM release also said consumers are "not spending as much as expected." Likewise, Texas Instruments cited "weak demand for personal computers and other devices that use microchips" in explaining why its quarterly numbers barely reached the mid-range of projections.

Analysts and investors also were disappointed that TXN didn't revise upwards its earnings and revenue forecasts for the full year. Instead, the company stuck with its previous estimate of $3.689 billion in revenue and earnings of 69 cents a share on.

"We'd all like to believe that consumer spending is onward and upward," NSM Chief Executive Donald Macleod told Reuters, "but I don't think it is."

That assessment sent semiconductor stocks lower and increased general concerns about the viability of the ongoing economic recovery, though the broad market held up fairly well. Part of the reason for that may be that historic sector-rotation models pointed to an easing of consumer demand at this stage in the market's rebound. Typically, the consumer and financial cyclicals are the strongest at the beginning of a market rally, then ease in the second stage, letting other sectors take the lead.

That's a bit confusing because one of the sectors that usually steps up in the second phase of a rally is technology, of which the apparently weakening semiconductors are a part. However, a number of analysts still think the chip stocks now carry more upside potential than risk.

James Stack, president of Stack Financial Management, said in a recent interview that he still expects technology stocks to replace the financials as leaders in the next upward wave. He put Intel and Microsoft Corp. (Nasdaq: MSFT) at the top of his recommended list, along with software producer Intuit Inc. (Nasdaq: INTU), the manufacturer of the QuickBooks accounting programs.

Stack calls Microsoft and Intel "forgotten giants" and says both are undervalued at current prices, especially given their lofty dividend yields. (Intuit has no dividend.)

Forbes earlier this month cited technology one of the "five sectors to hold," even if the market crashes. The article recommended Intel and internet-technology leader Cisco Systems Inc. (Nasdaq: CSCO), specifically. It noted that both companies are "at roughly a 20%-25% discount from their 52-week highs" and "positioned to grow their earnings by about 11% annually going forward."

Plus, in spite of the slowing growth pace, the SIA's Toohey remains optimistic for the sector.
"Sales in the first half of 2010 were exceptionally robust, driven by strong demand from a broad range end markets," Toohey says. "The continued proliferation of semiconductors into a broad range of products provides opportunities for industry expansion, even in a period of slower overall economic growth."

So, if you want to discount the rising concerns about the weakening recovery and the softening sales numbers for the chip makers, and instead take advantage of the current low prices in the semiconductor sector, what companies should you put at the top of your list?

Here are five stocks to consider:

  1. Intel Corp. (Nasdaq: INTC), recent price $19.42 (down from $21.24 in May) - Still the biggest name in the industry and No. 1 in sales worldwide.
  1. Linear Technology Corp. (Nasdaq: LLTC), recent price $31.21 (up from $28.23 in May) - Continues to lead the sector in performance if not in sales, and is among the few chipmakers to exceed its earlier revenue and earnings estimates. Still near its 52-week high of $33.06.
  1. Analog Devices Inc. (NYSE: ADI), recent price $30.56 (up from $27.74 in May) - Trailing 12-month earnings have risen from $1.16 to $1.95 and the company raised its dividend by 8 cents to 88 cents annually, representing a yield of 3.0%.
  1. STMicroelectronics ADR (NYSE: STM), recent price $7.65 (down from $8.12 in May) - Quarterly revenues rose by nearly $200 million (to $2.507 billion) and the elimination of past accounting charges resulted in a reported second-quarter profit of 39 cents a share, up from 6 cents last quarter and a 36-cent loss a year ago. The 28-cent dividend represents a yield of 3.85%.
  1. Advanced Micro Devices Inc. (AMD), recent price $6.80 (down from $8.38 in May) - An industry pioneer, AMD missed its quarterly earnings projection, showing an adjusted 6-cent loss instead of the 6-cent profit forecast. Full-year estimates were also lowered in the last report, thus the hefty decline in the stock price. AMD does not pay a dividend.

If you prefer to go the exchange-traded fund (ETF) route, rather than buying individual stocks, take a look at the iShares S&P North American Technology-Semiconductor Index (NYSE: IGW), recent price $46.57 (down from $46.62 in May), which tracks the S&P Semiconductor Index.

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