Room To Grow for Semiconductor Sector

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The New York Sun

We all want to be in the chips. A good way to get there, at least as far as the market goes over the near term, is to plunk your money down on chip stocks.


That, at least, is the thinking of Standard & Poor’s chief technical strategist, Mark Arbeter, who contends that the semiconductor sector – already up a sparkling and market-beating 22% this year in the first seven months – is still displaying positive weekly momentum, which suggests that the stocks have more room to run. Further, despite their price rise, he notes that the stocks are still selling below their early 2004 levels.


Leveraged buyout specialist Kohlberg Kravis Roberts apparently shares his enthusiasm for chips, having recently anted up a nearly $2.7 billion offer to buy the chip-producing unit of Agilent Technologies.


Supporting S&P’s enthusiasm, the chip stocks are humming once again in the second half, sparked, in part, by a number of renewed buy recommendations.


Mr. Arbeter argues that his bullish view was bolstered after S&P’s semiconductor index overcame technical resistance by breaking above an important trendline drawn off its 2002 and 2004 peaks. That signaled, he believes, a technical buying opportunity. Yet another plus: The semiconductor industry index is currently outperforming the S&P500 for the first time since 2003, which, together with the positive weekly momentum, also points to fatter chip stock prices.


The fundamental outlook is viewed as equally positive. Consumers spend about 30% of their discretionary income on electronics, which include a range of products that contain chips. And the view from the chief economist of S&P, David Wyss, is that consumer spending will remain relatively strong, which is prompting the advisory service to take a favorable view of the semiconductor group.


Okay, let’s say you buy S&P’s rosy outlook for chips. Which semiconductor stocks do you want to own? Five names, in particular, are said to fit the bill. Here’s a brief rundown from S&P on each one:


CREE: Strong demand for some of the company’s higher-priced products, including its brightest light-emitting diodes, should help Cree maintain a gross margin of about 50% over the long term. Fiscal 2006 (ending in June) should show about a 25% revenue gain. Earnings that year are pegged at $1.45 a share, up from an estimated $1.19 in fiscal 2005.


INTERNATIONAL RECTIFIER: The company designs semiconductors that refine electricity from wall outlets or batteries into a more usable form. The company, whose energy-saving products accounted for 28% of its June quarter revenue, will be a prime beneficiary of likely sustained high oil prices and new energy legislation. Earnings in fiscal 2006 (ending in June) are estimated at $2.91 a share, up from $1.91 in fiscal 2005.


MICROCHIP TECHNOLOGY: Solid prospects are in store for revenue growth in fiscal 2006 (ending in March) as this microcontroller company gains market share. Microcontrollers are the “brains” of most electronic devices. The company has a below-average risk profile with significant cash and no long-term debt on its balance sheet. It also has a yield of 1.6%. Fiscal 2006 earnings are estimated at $1.23 a share, up from $1.01 a year earlier.


NIVIDIA: The company should gain market share in its core market for graphic chips because recent agreements with Sony and Intel will have the potential to expand NIVIDIA’s longer-term business prospects. Likewise, operating margins are expected to widen to 12.6% in fiscal 2006 (ending in January) from 5.7% in fiscal 2005 due to an improved product mix and cost controls. Meanwhile, fiscal 2006 earnings are pegged at $1.44 a share, well up from $0.57 in fiscal 2005.


RF MICRO DEVICES: Revenue should rise 8.6% in fiscal 2006 (ending in March) based on a second-half recovery in the demand for cellular handsets, a reflection of seasonal strength. The company’s gross margin should also improve in the current fiscal year to about 38% from 36% in fiscal 2005 in response to an expected pickup in sales and greater manufacturing efficiencies. This year’s earnings are projected to rise to $0.8 a share, versus last year’s per-share deficit of $0.35.


In contrast, a Morningstar analyst, Alex Ross, takes a dim view of another chipmaker, Advanced Micro Devices, whose shares he views about 35% overvalued. Although AMD has improved margins and delivered new products, the analyst notes that the company labors under the shadow cast by the greater resources and position of the industry leader Intel and is unable to convert its success into acceptable returns on invested capital. AMD, he adds, faces a very difficult competitive situation, what with Intel commanding 80% of the microprocessor market and dwarfing AMD’s revenue 7 to 1.


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