A Slice of Gloom for Chip Stocks
Computer-chip stocks came under pressure Oct. 3 after a bearish earnings report from memory chip maker Micron Technology (MU) and a downbeat industry assessment from Morgan Stanley (MS) analyst Mark Lipacis, who issued "underweight" ratings on Intel (INTC) and its main rival Advanced Micro Devices (AMD), the world's largest makers of semiconductors.
In a note issued Oct. 2, Lipacis said he expects competition between AMD and Intel to take a toll on the price of chips. That came a day after Micron reported its third-straight quarterly loss and forecast price declines for the memory chips that make up the bulk of its sales. On Oct. 3, Intel share prices slipped 2.2%, to $25.81, while Micron stock tumbled 8.9%, to $10.74. AMD stock was little changed at $13.23.
Lipacis fueled bearish chip sentiment by writing that PC makers are likely to order double the number of chips they actually need. Such double ordering often happens ahead of periods of expected high demand—in this case, the yearend holiday season. Historically, the tactic has proven to backfire badly after the first of the year, when prices on chips fall as unsold PCs left over from the holiday season sit on shelves and chip factories are forced to slow production.
One way or the other a drop-off in demand is coming, either before or after the first of year, Lipacis wrote. Intel will come under extra fire from AMD, which is likely to ramp up production to generate much-needed cash. That extra production in turn will keep average selling prices under pressure. "Issues around overcapacity and the risk of double ordering will drive fundamentals and the stocks over the next 6-to-12 months," he wrote.
The outlook suggests a continuation of a long-standing tug-of-war between the two chipmaking giants. AMD has spent most of the year suffering a powerful counterattack by Intel, prompted by AMD share gains in the server chip market during 2005 and 2006. AMD's latest effort in the server space, a chip code-named Barcelona, was released last month (BusinessWeek, 9/11/07) but hasn't yet had measurable effect on the market. AMD pushed its share of the server chip market from 3% in 2003 to 26% by 2006, only to see it fall back to 13% by the second quarter of this year, according to research firm IDC (IDC). Intel has been using its advantages in the consumer desktop and notebook markets to counterbalance any advantages AMD may have in servers. Lipacis set a price target of $22 for Intel and $11 for AMD.
Few Holiday Hopes
Shares of Micron came in for an even bigger drubbing. The Idaho-based maker of commodity memory chips known as Dynamic Random Access Memory, or DRAM, said it posted a fiscal fourth-quarter loss of $158 million on sales of $1.44 billion, its third consecutive quarterly loss. The company also painted a picture of increasing problems on prices. Micron said it expects average selling prices on DRAM to decline by 10%, and prices on NAND-type flash memory chips, widely used in consumer electronics like Apple's (AAPL) iPod, which it manufactures through a joint venture with Intel, to fall 25%.
In both cases, Micron is competing against two South Korean giants, Samsung and Hynix Semiconductor (HXSCL), which together control the majority of the market and substantially influence prices, says analyst Ashok Kumar of CRT Capital Group.
"Samsung and Hynix have the ability to quickly shift back and forth between producing NAND and DRAM, and that gives them a better position from which to dictate prices," he says.
Even ahead of the holiday season, when PC sales tend to be seasonally stronger, Micron offered little hope of an improvement in conditions. Michael Sadler, Micron's vice-president of worldwide sales, said during a conference call that the amount of memory sold per PC had flattened during the quarter. "I attribute this primarily to concerns from our customers that memory prices were increasing early in the summer," he said. "As a consequence, [PC manufacturers] took steps to maintain reasonable control of system build and material costs, and used memory content as a lever to achieve that."
Healthy PC Market
Micron has been trying to reduce its reliance upon the DRAM business (BusinessWeek, 5/18/06) for years and in particular has been focusing on building CMOS (complementary metal-oxide semiconductor) image sensors, which are chips used in digital cameras, especially those embedded in wireless phones.
That gives little hope for Micron in the near term, says Robert Burleson of ThinkEquity Partners. "You have to estimate your revisions right ahead of when you might expect a positive seasonal move," he said. "November is when you see all the demand for the holiday sales, and if they're revising downward now, it's hard to know when to look forward and get excited."
Not every analyst is down on chips. JPMorgan (JPM) analyst Chris Danely issued a more positive note on the two chipmakers in a note issued Oct. 1, saying Intel is benefiting in part from a healthy PC market. He raised his Intel profit estimate for the calendar year to $1.27 per share, from $1.25, and estimates that Intel will post revenues of $37.8 billion, an improvement of $200 million over his previous estimate. His price target is $26.37.
Danely also says he expects Intel to gain market share back from AMD in the current quarter, particularly in the high end of the notebook PC market. "Although AMD should gain share in server processors until the second half of 2008, we believe Intel should remain dominant in laptop and desktop microprocessors," Danely wrote.
Recession Worry Ripples
Ultimately, the fortunes of chipmakers and computer makers, including Dell (DELL) and Hewlett-Packard (HPQ), will also ride on the strength of consumer demand heading into the end of the year. "The big question is if consumers show up for the party," says Kumar of CRT. "Otherwise, we'll have a situation with oversupply and price wars, and profit margins will collapse."
PC demand for now appears to be holding steady. Research firm Gartner (IT) says the market is on track to grow by 12.3% by the end of the calendar year, which would put unit sales for the year somewhere in the ballpark of 268 million. Gartner expects PC sales to grow another 11% on top of that in 2008. Still, while unit sales are up, prices on PCs sold have continued to decline.
Doug Freedman, analyst with American Technology Research in San Francisco, isn't worried. "Over the summer Wall Street was telling people to get ready for a recession, and so it should come as no real surprise that everyone is nervous," he says. "Fourth-quarter demand is going to be fine, if not a little better than everyone expects. But there are going to be some winners and losers."