6/10/2010
By Carlos Guillen, Semiconductor Analyst

It is clear that investors' fears about the current state of Europe's debt crisis have brought down stock prices across the board, particularly those of semiconductor companies. Perhaps as a gauge of semiconductor stock's performance, we can see that the Philadelphia Semiconductor Index (SOX) has decreased significantly from its one year peak reached on April 26, representing a drop of approximately 20.7 percent to the closing price on June 9. These fears, although somewhat overdone in my belief, have helped to correct a sector that was overpriced.

I believe semiconductor industry stock prices ramped much faster than they should have. Of course, that is not to say that semiconductor demand has not been ramping at better than expected rates; it's just that stock prices reacted too quickly to the good news. Now, the opposite is happening; investors have been spooked by the current weakening of the Euro, which resulted from high debt levels in countries such as Greece, Spain, and Portugal. Clearly, the belief is that the weakening Euro will cause a slowdown in European demand for semiconductors, since dollar denominated chips will become more expensive for European OEMs. While there is validity to this argument, I think the reaction has been blown out of proportion. Certainly, the increasing risk to decreasing demand should cause a devaluation of stock prices, but I should point out that, as a percentage of worldwide semiconductor sales, European semiconductor sales were only approximately 13.2 percent as of April 2010; this compares to 54.5 percent in the Asia Pacific region.

A slowdown in China would be much more precarious for the semiconductor industry, but despite Chinese efforts to raise interest rates, China is still expected to grow strongly. In fact, The OECD recently forecasted that China, India, and Brazil, should grow at 11 percent, 8.3 percent, and 6.5 percent, respectively, in 2010. The U.S. should grow at 3.2 percent in 2010, up from a prior estimate of 2.5 percent; Japan should grow at 3 percent, up from a prior 1.8 percent forecast, and even Europe is expected to grow at 1.2 percent, up from a prior forecast of 0.9 percent. Greece will be the only Euro nation with negative GDP. Also, despite the European debt situation, OPEC recently raised its world economic growth prospects for 2010 to 3.8 percent, up from its prior forecast of 3.5 percent presented a month ago.

In addition, there are still good news trickling down from the Semiconductor industry despite well know risks coming from Europe. Just last month Toshiba Corp., the third largest semiconductor player according to iSuppli, said it will ramp up its capital spending to approximately $14 billion over the next three years. A week after, Samsung Electronics Co., the second largest semiconductor player, unveiled its plans to more than double its spending on new factories and equipment to a record $15.6 billion this year, a sign of confidence in the rebounding economy. Two weeks after Samsung's announcement, Hynix Semiconductor, the world's second largest memory chipmaker, said it will increase its capital expenditure by a third to approximately $2.5 billion this year to take advantage of a strong recovery in the global technology sector.

More bits of good news came early this week from the likes of Texas Instruments, Microchip Technology, and Diodes Inc. Texas Instruments positively narrowed its revenue and earnings guidance for the June quarter of 2010. Revenue is now expected to be in the range of $3.45 billion to $3.59 billion, up from its prior guidance of $3.31 billion to $3.59 billion. According to management, orders have continued to run strongly, and lead times have decreased as production has ramped higher to meet customers' demand, but the company is still behind its delivery schedule. Even more importantly, management is not seeing a decrease in European demand. In fact, management said revenue from Europe was growing at about the same sequential pace as overall revenue. Microchip also recently reaffirmed its outlook for the June quarter, and said it expects adjusted earnings of $0.52 per share on revenue of $318 million. Moreover, management said it has seen the strongest ever first two months of the quarter in terms of bookings. Lastly, Diodes Inc. increased its June quarter guidance, and it now expects to post revenue of $147 million to $151 million, up from its previous forecast of $143 million to $148 million.

It is also compelling to see that market research firm Gartner once again increased its 2010 worldwide semiconductor revenue forecast late last week. Now the firm expects to see revenue reach $290 billion, up 27.1 percent from revenue of $228 billion reached in 2009. This forecast was actually encouragingly higher than Gartner's prior forecast calling for 19.9 percent revenue growth in 2010, which was provided in late February.

The improving outlook for the semiconductor industry has continued with The Semiconductor Industry Association's (SIA) most recent forecasts presented today. According to SIA, worldwide semiconductor sales are now expected to grow by 28.4 percent to $291 billion in 2010 and by 6.3 percent to $309 billion in 2011. This forecast represents a significant improvement from SIA's prior forecast calling for sales growth of 10.2 percent to $242 billion in 2010 and sales growth of 8.4 percent to $262 billion in 2011 presented back in November 2009. The Association also sees a return to seasonal demand and does not see any inventory accumulations at this time.

In general, all signs continue indicating that semiconductor revenue will grow at a stronger than expected pace in 2010. Despite the European debt situation, strong growth in other main economies is providing support for the semiconductor industry. It is also quite encouraging that most semiconductor companies continue to operate at lean inventory levels, and I believe that as end demand continues its momentum, semiconductor companies will have to build up inventories to prevent shortages, providing more lift to revenues. Moreover, an improving economic backdrop and a corporate sector that is slowly but surely ramping up spending should also fuel semiconductor revenue growth this year. At the moment, I see minimal downside risk in terms of corporate spending and am much more optimistic about a sharp upturn in IT spending in the second half of 2010. OEMs and distributors will continue to improve their inventory positions, although cautiously, and end-demand will continue to modestly increase.

Carlos Guillen
Wall Street Strategies