Where the Chip Stock Buys Are

Although the sector is enjoying a rebound so far this year, S&P analyst Thomas Smith thinks there's plenty of room for improvement

The semiconductor industry isn't exactly booming. But Thomas W. Smith, Standard & Poor's Corp. analyst of semiconductor and semiconductor equipment stocks, still sees a bright future. He's particularly optimistic about makers of such things as programmable logic devices (PLDs), an area where Xilinx gets a 5-STAR (buy) rating from S&P. Smith also likes the category of digital signal processing, in which Texas Instruments is a big player.

Intel, the chip giant, is suffering from the slowdown in personal computer sales, but Smith sees the stock as a stable way to invest in the arena and cites its 4-STAR (accumulate) S&P rating. And he's high on companies such as Taiwan Semiconductor because of the industry trend toward outsourcing manufacturing.

These comments were made in a chat presented Feb. 6 by BusinessWeek Online and Standard & Poor's on America Online, with Smith responding to questions from the audience and from BW Online's Jack Dierdorff. Following are edited excerpts from the chat. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: Before we get into the world of chips, what's your take on the overall market? How soon will we see the effects of the interest-rate decrease?


The overall market is in a classic recovery from a recessionary position that is being alleviated by lower interest rates. That is, the economy is in the middle of perhaps four weak quarters of economic growth. However, monetary policy turned in late December or early January, and stocks have been recovering since then.

For instance, in January the S&P 500 was up 3.5%, and some groups that react faster when monetary policy changes did much better, including semiconductor equipment. As tracked by S&P, it was up 32.5% in January. And semiconductors were up 18.6% in January. So we've already had some recovery, but there should be a lot more over the course of the year.

Q: Outlook for LSI this year?


On LSI Logic, we maintain a hold recommendation. The company is a good maker of logic chips and storage devices and has been involved with Sony Playstation 2 and other high-profile projects. However, their revenue run through the boom year of 2000 was not as high as we had hoped. They now seem hampered by the semiconductor industry slowdown in the usual way -- that is, they are looking for weak performance in the first quarter and probably second quarter, with hopes for better revenue and earnings in the second half of '01.

Q: Can you give your opinion on INTC (Intel)? Have held it for many years and would like to hear your opinion on future prospects.


We presently have a 4-STAR (accumulate) rating on the stock. Intel is still dominant in the largest category of chips, which is microprocessors for personal computers. They own the franchise. The bad news is that growth is slowing for PCs generally, and Intel is embarking on a strategy to diversify.... Personally, I view Intel as a good choice among the large mature chip companies. It should move more or less with the group and offer investors the stability of size, good production skills, and technical knowhow.

Q: Give me a good analog chip company for good growth.


Good question. There are several high-end analog chip companies with good growth and track records. Three that come to mind are Maxim Integrated Products (MXIM ), Linear Technology (LLTC ), and Analog Devices (ADI). Actually, let me name another: maybe Texas Instruments (TXN ).

Q: XLNX (Xilinx) -- why the wide price fluctuations with no overall improvement in position?


Xilinx is a 5-STAR recommendation. They are a leader in programmable logic devices, or PLD chips. The outlook there has been strong, but as we've hit the inventory correction for the group, Xilinx and its rival Altera (ALTR) saw their outlook on earnings change downward. The question is how long it will take for the excess inventory to be used up.

Q: Where do you see AMD (Advanced Micro Devices) in two to three years?


We have a 3-STAR (hold) ranking on AMD right now. For my part, I think AMD will continue much as it has in the past few years, alternating between good and bad quarters in their competition against Intel in the microprocessor arena. AMD has proven to be resilient, but it is doubtful in my mind that they can ever clearly overtake Intel.

Q: Your thoughts on AMCC (Applied Micro Circuits) for long term?


It has a 4-STAR (accumulate) rating. They compete as a supplier of high-speed silicon equipment. They are something of a highflier and should do well in the long term. They are suffering right now from order pushouts and cancellations like other chipmakers in the group... In the same category, I cover Vitesse Semiconductor (VTSS ) with a 5-STAR ranking, Broadcom (BRCM ) with a 4-STAR ranking, and PMC-Sierra (PMCS ) with a 2-STAR (avoid) recommendation. PMC was particularly hard hit by the inventory correction.

Q: Is TSM (Taiwan Semiconductor) a good long-term buy?


Yes. Taiwan Semi is very well-positioned for the long run. They are the leading dedicated chip foundry at a time when outsourcing chip production is becoming more popular. So whatever growth the industry shows, Taiwan should be able to grow 3% to 4% faster. For instance, if the industry grows 17% a year, then Taiwan ought to be growing at 20%.

Q: Can you tell what you think of the future for ATML (Atmel)? Were they hurt by the INTC deal for flash memory?


We have a 5-STAR recommendation on the stock. While competition in the flash memory business is always a concern, this company does very well. Plus, the inventory overhang hasn't really developed for flash memory. I think there is ample room for Micron (MU ), Atmel, and Intel in this arena.

Q: Do you like Vishay (VSH )?


Yes, I like Vishay. I still have a 4-STAR ranking on it. They reported today on a superlative year 2000. And like other chipmakers, they guided revenue and earnings estimates down in the first half and looked for recovery in the second half of the year. They suggested that revenue would be approximately flat for the year 2001, which at first glance sounds disappointing. However, 2000 was a huge year, and to hold those gains would be a really strong accomplishment.

Q: How about IDTI (Integrated Device Technology)?


I believe that stock is undervalued. I have a 5-STAR ranking on it. They sell into the communications industry, and their fortunes go along with that of Lucent (LU ) and Nortel (NT ). The stock was knocked down last fall and is making something of a recovery now. I estimate calendar '01 earnings of about $3.37, which should make for an attractive opportunity. The stock closed today around $41, getting a p-e in the low teens. This seems too cheap to last, especially if the economy strengthens in the second half.

Q: What are your thoughts on Flextronics International (FLEX ), one of my largest holdings)?


On Flextronics, a contract manufacturer, we have a 5-STAR ranking.... I know my colleagues like the contract manufacturers quite a bit because of a substantial trend toward outsourcing. Flextronics ought to see a few percentage points of growth because of that trend.

Q: What chips can we expect to make us some money in the next year? Putting it another way, can you review your 5-STAR list for us now?


Categories we like include PLDs, made by Xilinx and Altera, which can take market share from other categories as PLDs become more powerful at lower cost. I would steer away from PC-oriented chips such as Intel and AMD and Micron, which make memory largely for the PC sector. I like high-end analog chips such as a Maxim, Analog Devices, Linear. Digital signal processors is also a good category -- Texas Instruments and ADI. And at the high end, there are some highfliers such as VTSS, but aggressive traders might look at Broadcom and PMC-Sierra after the Cisco report settles out through the news.

Edited by Jack Dierdorff

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