Chipmakers Turn Cash into Dividends

Despite Intel's recent lower forecast, S&P's Tom Smith is positive on semiconductor stocks, citing dividends and overall growth

Analog Devices (ADI) delivered good news for investors on Mar. 14 by boosting its quarterly dividend to 16 cents a share, from 12 cents, and authorizing the repurchase of up to $1 billion worth of stock. "They have a lot of cash on hand and need to do something with it," says Tom Smith, semiconductor analyst for Standard & Poor's Equity Research.

In the past few years, some chip companies have started to pay dividends to shareholders and have even raised them. "Some of these companies are like piggy banks," Smith says, and have enough cash to get through cycle downturns.

Overall, Smith is positive on semiconductor stocks. "It's a particularly good growth industry," he says, noting that the Semiconductor Industry Association anticipates average annual revenue growth of 8% to 10% for the next few years. His recommended stocks include Altera (ALTR), which is ranked strong buy, along with Microchip Technology (MCHP), Marvell Technology Group (MRVL), Broadcom (BRCM), Advanced Micro Devices (AMD), and Xilinx (XLNX), which are ranked buy.

BusinessWeek Online's Karyn McCormack recently spoke with Smith about dividends, Intel's (INTC) recent lower forecast, and other chip trends. Edited excerpts of their conversation follow.

Note: Tom Smith is a Standard & Poor's Equity Research analyst. He has no ownership interest in or affiliation with any of the companies on which he writes research. All of the views expressed here accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this story.

Are you seeing more chip companies paying or raising dividends?

An interesting phenomenon has come up in the semiconductor group in the past four years. Some players, mostly in the analog area, have grown to a point where they have ample cash on hand for development and to sustain the company through business cycle downturns.

These companies often have wide margins and might not have acquisition opportunities for a constructive use of the cash. So in recent years, in addition to making share buybacks, these companies have begun to introduce and/or increase their cash quarterly dividends.

One of the highest dividends now paid by a semiconductor company comes from Microchip Technology, which we rank 4 STARS (buy). Microchip makes microcontrollers. However its financial model resembles that of many analog companies in that it has a diverse customer base and tends to have steadier revenue and earnings streams than most semiconductor companies and, generally speaking, wide margins.

Just today [Mar. 14], Analog Devices announced a dividend increase and authorization to repurchase $1 billion worth of stock. It raised its dividend to 16 cents a share, which gives it a yield of 1.7%. Another high-end peer, Linear Technology, also has a yield of 1.7%.

Intel has been paying a dividend for some time and works a different business model from the others. It has a yield of 2%. I'm looking at a yield of 1.4% for Maxim Integrated Products (MXIM). Texas Instruments (TXN) is another name that has been raising the dividend, but from a lower level, and its yield is about 0.4%.

For the established high-end analog companies, there's an opportunity for investors to get a growth company that pays a dividend of over 1% and, in our opinion, has a good chance of growing its dividend over time. This might be seen as a sign that parts of the industry are passing into middle age. It's true that the microchip is almost 50 years old. Some of these analog companies are quite well established and have grown to be of considerable size and growth stage.

Of course, the semiconductor industry is still an interesting area to look at for startup companies that are trying to create a business around a particular chip design, and these have young company characteristics and usually no dividends.

Intel recently lowered its first-quarter revenue forecast. Is it losing market share to AMD?

Intel's warning on Mar. 3 was some of the biggest news for the chip industry in recent weeks, partly because it went against the pattern of solid sales progress that we've been hearing from most chipmakers. Intel had been part of that pattern through its early December report for the fourth quarter of 2005 -- it was still telling a strong story for sales. When it reported results in January, it caught many by surprise because the company didn't do as well as expected and the stock fell.

So the story turned in late January. The company also said that it would not to do mid-quarter updates any more. But apparently the pace of business was so much slower than they had guided for in early January, that in early March it decided to issue a press release about slower sales and lower margins.

In Intel's March statement, it observed both slower demand and loss of market share. Intel stressed the weakness in demand more than the market share. This might be true, but skeptical analysts may think the market share loss may be more than Intel suggests.

The whole PC food chain shuddered a bit on Intel's news because the amount of revenue reduction suggested it couldn't all be share loss, and PC sales must be tracking lower than expected. All other chips that ride on a PC may be affected, like analog, power management, connectors, etc. Subsequent to the report, AMD stock, rather than going up based on market share gains, went down, presumably pressured by the notion that PC sales might be tracking lower than expected.

Another pressure on AMD shares would be if Intel is hurting, it might snap back with price cuts. Historically, Intel has responded to market share losses with price cuts, and the price wars can turn into extended battles. AMD shares have fallen since Intel's warning, but today the stock was up along with the group, so perhaps the news has been absorbed. After Intel's Mar. 3 news, we downgraded the stock from 4 STARS (buy) to 3 STARS (hold), and upgraded AMD from 3 STARS to 4 STARS.

Which types of semiconductors are selling the most strongly?

One of the larger classes of chips that we expect to sell above the pace of the market is analog chips, which is a broad category including chips used for power management for all kinds of electronic devices. In an era of a great number of handheld devices, such as handsets and iPods, power management is a pretty good category.

Also, the general explosion of applications that are trying to capture real-world signals like light and sound -- for example, in digital cameras and cell phones -- need a digital signal processor and a cluster of analog chips around it. These are also used for medical equipment that, for example, measure heart beat and give a digital readout. There are a lot of niche products that use these chips. In automotive electronics, there's a move to capture tire pressure information and send a wireless signal to the dashboard of the car.

What about flash memory?

Another hot area is NAND flash memory, which is riding the handheld portable-devices market. NAND was popular last year, and pricing for NAND was very strong and entered 2006 strong. The thinking was that adding capacity to meet demand would push prices down in 2006, and prices have already begun to fall for NAND flash. Nevertheless, it's a nice category to be in.

An interesting development was Intel and Micron (MU) joining together to get into the NAND flash market. Along these lines, Micron recently announced an agreement to acquire Lexar Media (LEXR; not ranked by S&P), which is another way Micron can diversify away from commodity DRAM and into more types of specialized memory chips that carry higher margins.

You also like a few programmable logic chip makers.

Programmable logic is another type of chip that should grow sales faster than the overall market, and it has been that way in recent years. The Semiconductor Industry Association (SIA) is looking for worldwide semiconductor growth for 2006 to be up 7.9%. It estimates that a category of chips called standard cell field programmable logic devices (FPLD) will be a $13 billion market in 2006 and will grow 17%.

We have the two main players as stocks picks: Altera is 5 STARS, and Xilinx is 4 STARS. We have 3 STARS on a smaller programmable chip maker, Lattice Semiconductor (LSCC). Altera and Xilinx confirmed March quarter guidance last week, and Lattice guided higher. So we see the programmable chip market on track for a good year.

What about broadband chips? Which companies do you like in this area?

Broadband continues to be an area where certain companies have been able to string together some very impressive quarterly sales growth in the past 12 months, and indicate revenue growth approaching three times the industry average. These include Marvell Technology Group and Broadcom, which are ranked 4 STARS. For the near term, we expect both companies to have technology advantages in rapid growth niche markets.

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