Logical Bets for the Chip Market

ChipInvestor.com's Manoj Nadkarni, who sees analog and programmable logic devices leading a sector upswing, likes Nvidia and Actel

For investors keen on semiconductor stocks, the best bets for the next up cycle will include companies making analog chips and programmable logic devices. And among the end markets, the consumer sector is the strongest, thanks to such products as digital cameras, third-generation (3G) cell phones, and DVD players.

That's the word from Manoj Nadkarni, who is president of ChipInvestor.com and editor of its newsletter. Among companies he finds interesting are Nvidia (NVDA ), which makes graphics chips for PCs and video-game consoles, and Actel (ACTL ), which is strong in chips for consumer communications products and the military. Nadkarni made these remarks in an investing chat presented Jan. 30 by BusinessWeek Online on America Online, in replying to questions from the audience and from Karyn McCormack of BW Online. Following are edited excerpts from this chat. A complete transcript is available from BusinessWeek Online on AOL, keyword: BW Talk.

Nadkarni has provided this disclaimer: Different company examples in this chat are for the purpose of illustrating ideas. They are not an endorsement by Mr. Nadkarni or ChipInvestor.com, nor a recommendation or offer to buy or sell securities. Any action any investor may take as a result of the discussion here is strictly at his or her own risk. Mr. Nadkarni or ChipInvestor.com shall not be liable for any gains or losses resulting from such actions. You should be aware that Mr. Nadkarni has positions in some of the stocks discussed.

Q: Intel (INTC ) had big news when it lowered its capital-spending projection. What's your take on that?


Intel is the largest customer for many equipment makers, so that's going to hurt equipment companies. However, we think that this isn't indicative of an industrywide phenomenon. Intel spent a lot more in the last few years, so it already has two 300mm. wafer plants producing Pentium IVs efficiently. However, if you look at other segments of the chip industry, memory producers like Samsung, Toshiba (TOSBF ), and Micron (MU ) are expanding.

Q: What types of semiconductors show the most promise? And which companies will benefit the most?


Probably the strongest segment is the consumer sector. Products like digital cameras, third-generation cell phones, and DVD players are driving growth. The PC sector, we think, is stable, with growth being stagnant in the U.S. and in Western Europe, while there's a strong increase in China and other parts of Asia. The communications segment in the recent past has been the weakest, but we're probably at a bottom there. So how a particular company is doing depends on its exposure to these different markets and its competitive position.

Q: What chip stocks are you recommending?


There are some segments of the chip business that we like...well-managed companies with good long-term growth prospects and reasonable valuation multiples, we look at these. One is Nvidia (NVDA ), a leading producer of graphics chips for PCs and game consoles. Its upcoming GeForce FX family of chips looks promising, but it will take one or two quarters before meaningful revenues begin. The company is gaining share in the mobile segment. Nvidia has some near-term challenges, including strong competition from ATI Technologies (ATYT ) and Intel. The valuation multiples look good. I have a position in this stock, and we have a "buy" rating.

Q: Is this a good entry point for Applied Materials (AMAT )? It closed at [$12.02 on Feb. 3].


As you know, Applied Materials is the largest producer of chipmaking equipment. The stock valuations are reasonable -- the company expects revenues to drop 20% in the January quarter. We think AMAT will meet or exceed the guidance. The order rates for equipment companies are near bottom, and a small uptick is likely in the first half of this year.

Q: What is your take on chip stocks LSI Logic (LSI ) and Texas Instruments (TXN )?


LSI is a leading ASIC producer, and because the company has guided lower, its stock suffered recently. Regarding TI, the company is benefiting from growth in the wireless sector, specifically chips for the newest-generation handsets. The last quarter was better than original projections. Now TI is guiding for flat revenues in the first quarter. We think valuations are reasonable.

Q: What's your opinion of KLA-Tencor (KLAC )?


KLA is a leader in equipment for defect detection and for improving manufacturing yields. It's a well-managed, profitable company. We think KLA is well-positioned to benefit when the next upturn comes. The company has guided for flat orders and slightly lower revenues in the current quarter.

Q: Do you have an opinion on Taiwan Semiconductor (TSM )?


As you know, TSM is the largest -- and one of the most successful -- foundries in the world. We don't follow the company that closely, except to see how it influences business of fab-less companies that we're interested in. We're also interested in how their capacity-expansion plans affect the equipment industry.

Q: What, in your view, are the up-and-comers in semiconductor capital equipment?


I can make a few general comments about the equipment industry. While chip companies aren't doing badly, many have curtailed their expansion plans, and that hurts the equipment industry. As we talked about before, there are fewer new investments from PC-centric companies and foundries, and more from memory producers. That's because memory is being used in greater quantities in various consumer gadgets. So if you are interested in equipment companies, you may want to look at companies that serve the DRAM and flash-memory business more than the logic business.

Q: What about Analog Devices (ADI )?


ADI is a major analog chipmaker. We covered this company previously. It's well-managed, [and] it should see an improvement in margins as it consolidates manufacturing activities to newer wafer plants. Certainly, you want to take a close look at this company if you're interested in analog chipmakers.

Q: What's your opinion on Advanced Micro Devices (AMD ) and Motorola (MOT )?


I don't have an opinion on Motorola, but we'll talk about AMD. They're a leading producer of microprocessors and flash memory. For the December quarter, the company had record microprocessor unit shipments. We think the pricing environment is stable. AMD's slightly behind in the desktop space, but that should change with the Barton chip to be released soon. They are more competitive with mobile processors. Of course, if you are interested in AMD, you need to follow Intel closely, too. AMD's future depends on timely and flawless introduction of the Hammer family, its next-generation microprocessors.

Q: What advice would you give investors interested in the chip sector? Should they wait for evidence of a recovery before buying?


If you wait for the recovery to happen, that will already be reflected in stock prices by the time you enter the market. The best times to get into chip stocks or tech stocks are when they're badly beaten down.

Edited by Jack Dierdorff

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