above-seasonal Trends For Semi Components
TWST: Tell me about your coverage. What do you cover within the semiconductor space?
Mr. Gerra: I cover a mix of large caps and small-cap names, semiconductor components only. Among large-cap names, we cover Intel (INTC), Texas Instruments (TXN), STMicro (STM), and Broadcom (BRCM). Analog names under coverage include ON Semi (ONNN), Fairchild (FCS), Diodes (DIOD), Monolithic Power (MPWR) along with Analog Devices (ADI). We cover a couple of memory companies, SanDisk (SNDK) and Micron (MU), as well as communication names, including NetLogic (NETL) and Broadcom.
TWST: What is the status of the semiconductor component sector right now?
Mr. Gerra: We continue to expect an upcycle for most of this year, which would be a continuation of what we saw since last February of 2009. The reason we believe the cycle would extend a few more quarters is that the inventory levels remain at historic lows in the supply chain. We've seen a slow resumption in true end demand, and the supply chain hasn't been able to catch up. So we think that until we see the supply chain normalizing, we think trends are going to continue to be above seasonal for semiconductor companies.
TWST: What are the challenges in the supply chain?
Mr. Gerra: Because the supply chain to some extent overreacted late 2008/early 2009 by drastically cutting down inventories below what was the real trend of end demand, the supply chain is trying to catch up with the ongoing recovery in end demand but hasn't been able to do that. So lead times, as a result, have expanded pretty drastically for some components. In some cases, lead times are stretching over 20 weeks, and we're not at a point yet - even after a few quarters, where we are seeing replenishments - where lead times are coming down. So we are in an environment where demand is stronger than supply at this point.
TWST: Did supplies go down because of the economy?
Mr. Gerra: Well, the triggering point was retail sales in the U.S. well below expectation in October and November of 2008, and that was in the context of people having significant concerns about the economy and what was happening in terms of banks. So as soon as people saw the weakness, they drastically cut orders in order to reduce inventory levels.
TWST: What else is happening in the component sector?
Mr. Gerra: I think we are likely to see potential increases in wafer pricing this year, which is the result of utilization rates being around 100% at some of the major foundries in Taiwan; that's one issue. Component pricing could pick up a little bit, particularly on the commodity side, which would be the first time in several years we have seen that. So net-net, it's about ramping capacity but gauging what real end demand is, and being in a situation where we could potentially have overcapacity again exiting this year.
TWST: In general, are you positive on this sector?
Mr. Gerra: We are positive on this sector for 2010 because of the upcycle that we expect for the next few quarters and the fact that until we see inventory levels at least normalizing, we would expect above-seasonal trends in terms of semiconductor revenues.
TWST: Let's talk specifics. Tell us who you like right now in this sector and why.
Mr. Gerra: In the large-cap space, we like Intel. The reason we like Intel is a combination of new product cycle and valuation. Intel right now has launched, or is in the process of launching, new products targeting various segments of the PC market, whether it's the mainstream in desktop and notebooks, or whether it is servers at the high end. Intel also has a new product offering for netbooks in the high-volume, low-end segment of the PC market. One of the catalysts is Windows 7, particularly since a number of companies never upgraded from XP to Vista. We think that Windows 7 is going to act as a catalyst for a corporate notebook/desktop refresh starting this year, and that's what we started to see happening. We also see a server refresh in the second half of this year, based on higher IT budgets for this year and new, high-performance products (Xeon) from Intel. From a valuation standpoint, Intel is trading at less than 13 times of 2010 EPS estimate, which is a five-year trough. I think the reason the stock is trading at those levels is because of investors' reluctance to buy a stock near peak gross margin. We are modeling gross margin holding at or above the high end of the target range for Intel this entire year. As investors see continued EPS momentum in the second half for Intel, the stock should rally back in our view.
TWST: Who else do you like?
Mr. Gerra: We like ON Semiconductor as a mid-cap analog name due to a combination of market share gains and continued strengths in analog trends. The company continues to gain market share, specifically in PCs, in notebooks and desktops, and also in the European automotive market. We also expect some share gains in the mobile phone area this year as well, driven by new design wins. The stock's valuation is attractive currently, with strong cash flows while the company is deleveraging the balance sheet. We also like Micron. Micron is a leading memory vendor based in U.S. We expect a continuation of the upcycle, which started in the second half of last year, which we think will lead to profit growth and positive free cash flows this year. We are currently expecting demand to be stronger than supply, inferring pricing should track above seasonal and should lead to a continuation of margin expansion for Micron. We also expect Micron to gain market share this year because of their joint venture with Nanya (2408.TW). Micron also benefits from a joint venture with Intel, which gives them cost leadership currently in NAND flash, which should lead Micron to continue gaining market share. We expect supply-demand to be about in balance for NAND flash this year, which should also be positive.
TWST: What trends will we see in the sector in the next few years? Should we expect mergers or consolidation?
Mr. Gerra: There has been discussions about consolidation for years. It's a process that is slowly ongoing, but we don't predict any acceleration in that process, particularly in a year where we expect the market to rebound and as such, companies return back to profitability. Longer term, however, we do expect continued consolidation only because there is a slowing of the growth in semiconductor revenues from the mid-teens that we used to see 10 years ago to what is now probably 6% to 8% growth per year. Consolidation will likely continue, as the industry remains very fragmented, but this process is likely to take many years.
TWST: What about international outsourcing?
Mr. Gerra: Semiconductors are either produced at facilities owned by semiconductor companies or outsourced to companies which specialize in manufacturing the semiconductor based on specifications from any given semiconductor company. The fabless trend has taken place for a number of years and is expected to continue, and we see a continuation of existing trends where the fabbed model will only remain in the hands of the largest-volume suppliers, such as Intel, for example.
TWST: Would you say investors should have this sector in their portfolios?
Mr. Gerra: Yes, given the positive stance we have on the semiconductor space for the first three quarters of this year.
TWST: Any other things investors should watch out for in the sector?
Mr. Gerra: It's a very cyclical industry. In the semiconductor space, there are a number of signs to watch for that could indicate the end of a cycle, including lead time contraction, cancellations and higher inventory levels. Semiconductor stocks have experienced a significant pullback last January, as investors sold on the good news. On the basis of our belief semiconductor earnings will peak this 3Q for many companies, rather than last 4Q, stocks should rebound this 2Q.
TWST: Tell us about your background.
Mr. Gerra: I have been at Robert W. Baird for about five and a half years, covering the semiconductor component industry. Prior to that, I spent time at SoundView Technology and was also at Prudential for about five years. I have been covering the semiconductor industry since 1999.
TWST: Thank you. (LMR)
Note: Opinions and recommendations are as of 02/02/10.
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