Analysts Look to Small-Cap Chip Stocks for Value
Friday January 11 4:06 PM ET
By Duncan Martell
SAN FRANCISCO (Reuters) - For investors looking
to profit from a cyclical recovery in semiconductor
stocks this year, analysts and money managers
have this advice: think small.
The rally that took hold late last year in anticipation
of an upturn in chip demand has stretched
valuations, particularly for the big name players, so
investors looking to mark gains in 2002 might want to scour small- and mid-cap
companies, analysts said.
The Philadelphia Semiconductor Index (^SOXX - news), which includes the best-known names in the chip and
chipmaking-equipment industry such as Intel Corp. (Nasdaq:INTC - news) and Applied Materials Inc.
(Nasdaq:AMAT - news), has already soared 62 percent from its Oct. 2 low.
Now, for investors insistent on buying into the semiconductor sector, which analysts and investors say is
extremely overvalued given earnings prospects for this year, selectivity and focusing on smaller companies
becomes paramount.
Take Intel. The world's biggest maker of semiconductors has a market capitalization of $237 billion and is trading
at 56 times its projected 2002 earnings per share of 62 cents, according to Thomson Financial/First Call. Intel
stock has surged 77 percent since Oct. 2.
``Most of the easy money has been made in the large-cap semiconductor and semiconductor-equipment
companies,'' said Justin McNichols, portfolio manager with San Francisco-based Osborne Partners Capital
Management.
In the fall, portfolio managers made a bet that chip stocks were the right place to be, reasoning that, because
chips had been hardest hit of all the major technology industries in 2001, shares of chip companies couldn't
really fall much farther. It turns out they were right.
Texas Instruments Inc. (NYSE:TXN - news), which ranks as the second most valuable company in terms of
market capitalization in the Philadelphia Semiconductor Index, at $48.9 billion, is a similar story.
CHEAP A RELATIVE TERM
Shares of the biggest maker of digital signal processor chips used in cellular phones have risen only 19 percent
since Oct. 2 lows, but are trading at a sobering 689 times projected 2002 earnings, though that ratio declines to
44 as a multiple of 2003 earnings estimates.
That kind of lofty valuation explains why analysts are looking to smaller chip companies in 2002 to recommend to
clients. In the mid-cap arena, Pacific Growth Equities analyst Jim Liang likes Actel Corp. (Nasdaq:ACTL - news),
a maker of field-programmable gate array chips that customers, often in the telecommunications industry, can
program to fit their product needs.
``We believe this is a company that's well positioned to participate in the anticipated cyclical recovery in the
communications semiconductor story,'' Liang said. Actel's market capitalization is $516 million.
It's also a lot cheaper on a price-to-earnings basis than its larger competitors Xilinx Inc. (Nasdaq:XLNX - news)
and Altera Corp. (Nasdaq:ALTR - news). Actel's forecast 2002 price-to-earnings ratio is 100, compared with 210
for Xilinx and 108 for Altera. Actel stock has risen 36 percent since Oct. 2 while Xilinx' has jumped 93 percent and
Altera's has gained 62 percent.
``To the extent the company can execute on its growth strategy and its new product roll-outs, it could close the
gap on its valuation discount to its peers,'' Liang said.
Some analysts are also pointing to somewhat significant differences in performance between the large-cap
companies they cover and the small- to mid-cap ones.
SMALL IS BEAUTIFUL
Sidestepping the issue of valuation, Needham & Co. analyst Dan Scovel said: ``For the big-cap guys, business
now is pretty bad, but for the smaller-cap guys, their business is actually pretty good on a relative basis.''
Scovel, while noting that he believes chip stocks are overvalued, said he thinks Zoran Corp. (Nasdaq:ZRAN -
news), a maker of chips used in DVD players, is positioned for a potentially strong year. Sales of DVDs and
players are breaking records as the new technology's popularity is approaching that of videotapes.
``Eighty-five percent of their sales come from DVD players and that market has been very strong,'' Scovel said.
Zoran's market capitalization is about $600 million, and, while its shares have gained 59 percent since Oct. 2, its
forecast 2002 price-to-earnings ratio is a more reasonable 43.
The boom-and-bust chip industry has tended to run in up-and-down cycles of about four years and has
rebounded from downturns quickly in the past. The Semiconductor Industry Association, the leading trade group,
forecast a 6 percent gain in sales this year to $150 billion, but a sharper 21 percent gain in 2003.
``In semiconductor equipment we're looking more toward a particular niche as a strategy and in semiconductors
we're concentrating on valuation and later recovery situations,'' McNichols said.
PATIENCE A VIRTUE
He pointed to LSI Logic Corp. (NYSE:LSI - news) as an example.
``There's really no interest in LSI right now because there's virtually no way they can make money in 2002,''
McNichols said. ``But in late 2002 and 2003 they'll have leverage they haven't had in past cycles.
LSI, one of the largest makers of application specific integrated circuits, or ASICs, has been looking to boost the
outsourcing of its chip manufacturing to companies such as Taiwan Semiconductor Manufacturing Co.
(2330.TW), he said. ASICs are used in auto emission control, environmental monitoring, personal digital
assistants and others applications.
LSI shares have gained 42 percent since Oct. 2 and analysts on average forecast the company to lose 43 cents a
share in 2002, according to First Call. The stock was trading on Friday at $15.79 on Nasdaq.
``We like LSI in the low teens,'' McNichols said. ``There really aren't any semiconductor companies that are
established, very well known, have very good books of business and you can say, 'Hey, I can get this for a few
points lower with a lot of upside later in the cycle.'''
AI
