The semiconductor sector may be worth examining due to signs of firming global growth and the backdrop of favorable expectations for electronic sales. The U.S. manufacturing PMI has posted readings in the mid 50’s over the past two months recovering from a recent low of 49.0 in May. At the same time, the August JP Morgan Global Composite Output Index rose 1.2 to 55.0, hitting a two and half year high and suggesting the growth picture is not limited to the U.S.
Smart phone and tablet demand expected to grow:
The upswing in economic growth is complemented by a favorable outlook for the sale of technology product. The International Data Corporation recently forecast that global smartphone shipments would rise 40% in 2013 to over 1.0 bln phones. Carrier subsidies and lower cost devices were expected to fuel growth. By 2017, smart phone shipments are projected to hit 1.7 bln units. However, the IDC did cut its outlook for 2013 tablet sales by about 2 mln units to 227.4 mlu.
None-the-less, longer term growth is expected to be healthy with worldwide shipments projected at 407 mlu by 2017.
Semiconductor capital spending is forecast to rise with sales:
The SEMI World Fab Forecast suggests that spending on fab equipment will rise 25% to a record $39.4 bln in 2014. Moreover, spending is expected to rise 30% to 40% in the second half of 2013 compared to the first half of 2013. Strong capital spending will be supported by healthy sales, as Semiconductor revenues are projected to rise 8% in 2014. Aggressive capital spending plans are a vote of confidence in sales and the semiconductor industry’s health.
Backlog is building:
The book to bill ratio in North America has been 1.00 or above since January 2013 and points to healthy activity in the semiconductor sector. Moreover, the growth in bookings rose into positive territory on a year over year basis in July and may be pointing to an upswing in demand. Comparisons are easy and the rise in bookings could benefit investor interest in the sector.
Looking at the chip sector from another angle, the Commerce Department’s unfilled orders for computers and electronics products continues to trend higher and work above the old peak established in 2000. The growth rate is also positive on a year over year basis pointing toward continued expansion. The trend in backlog is a positive sign for future business activity.
Names to watch
In order to narrow down the candidates for investment in the semiconductor sector, a handful of companies with a Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy) were examined. The table displays the names, ticker symbols, and valuation measures for each of the companies in the sector. Three valuation measures were chosen to screen the companies for investment value.
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Price to tangible book: This valuation looks at the price relative to the theoretical breakup value of the company. Because of the cyclical nature of earnings in the chip sector, the tangible book value of the company should gradually work higher over time if the company is successful in generating profits. Intangible assets, like goodwill, are taken out of the equation as they have little impact on breakup value. Because of the cyclical nature of the chip sector, earnings can be negative or small at times which makes it more difficult to use a price to earnings ratio to analyze valuation. Companies with low price to tangible book values are deemed as inexpensive or possessing value.
Price to sales: This measure uses the share price divided by sales per share to determine if a company is cheap or expensive. The semiconductor sector is cyclical and as a result companies can swing from being unprofitable to profitable. The price to sales ratio may be a stronger indicator of company valuation and potential profitability. A low price to sales figure is a sign of cheap valuation.
PEG ratio: The PEG ratio measures the price to earnings ratio relative to the growth rate of earnings per share. Semiconductor shares can be fast or slow growing companies at times, so high PE ratios must be viewed in the context of the growth rate in earnings. Looking at the PE ratio by itself may distort the valuation. A PEG ratio of 1.0 suggests that the price to earning s ratio is in line with the growth rate. Values near or below 1.0 would been seen attractive. An investor would not be “over paying” for growth.
In order to provide a summary or conclusion, each stock was given a position number for each of the valuation measures. A 1 indicates the most attractive valuation or lowest value in the table, while a 9 indicates the most expensive valuation or the highest value in the table. The position numbers were averaged. The lowest average is in theory the most attractive stock, while the highest average would be the least desirable stock.
Breaking out the results:
On the basis of the price to tangible book ratio, Triquint (TQNT) is the cheapest, while Cyprus (CY - Analyst Report) is most expensive.
Looking at the PEG ratio, MagnaChip is the most inexpensive, while Supertex (SUPX) is the most expensive. However, MaxLinear (MXL - Snapshot Report) has a negative or non-meaningful value, which puts it in the highest position of 9.
Based on the price to sales ratio, Monliithic Power (MPWR - Snapshot Report) is most richly priced, while Magnachip has the lowest ratio and appears most attractive.
MagnaChip and Triquint posted the lowest average values at 2.00 and 3.00 respectively. They appear most attractive based on the combination of valuation measures. MagnaChip is priced well below its expected growth rate and less than 1.0 times sales. MagnaChip designs and manufactures analog and mixed signal semiconductor products with applications in the tablet, mobile phone, automotive, and power supply space, to name a few. Triquint makes chip products with applications in the defense/aerospace, networking, and mobile device industries.
SanDisk (SNDK - Analyst Report) and Intersil (ISIL - Snapshot Report) were also on the cheap side. Their PEG ratios were near or below 1.0 and their price to sales ratios were below 2.50. SanDisk makes flash memory and storage devices, while Intersil is a designer and manufacturer of high performance analog semiconductors. It has exposure to a broad range of telecom, broadcast, solar, energy, industrial, and auto industries.
When choosing a stock, earnings may be as important or more important than valuation. Just looking at valuation can lead to a “value trap”. In a value trap, a stock looks cheap based on measures of valuation, but is priced with a discount for a reason – there is a limited growth outlook.
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There has not been great movement in earnings estimates in the chip sector – see the table. Monolithic Power has actually shown the greatest upward revision to 2013 and 2014 earnings per share estimates. Its valuation was toward the poor side of the group, and it appears the market is pricing strong growth. Notice that EPS estimates have been increased $.07 to $0.62 this year and $.08 to $.90 next year. It is forecast to post a vibrant 45% increase in earnings growth, but is priced at 5.41 times sales.
Magnachip saw its 2013 EPS estimate cut by $.01 for 2013, but the 2014 EPS forecast was raised $.06 to $3.00. It is expected to post a 20% growth rate. The upward revision to 2014 should offset the downward revision to 2013.
It should be noted that there were no other changes to estimates over the past 30 days and Cyrpus is expected to post the quickest change in EPS growth from 2013 to 2014 at 189%. Notice the relatively high PEG ratio.
The combination of inexpensive valuation and earnings revisions suggests that MagnaChip may provide an attractive investment opportunity. It wins the award for the best pick in the small universe examined. It has the combination of the cheapest valuation and upward revision to earnings estimates.
Triquint, SanDisk, and Intersil would be the next picks based on valuation and their Zacks Rank of #1 or #2.
With signs of stronger economic growth, a healthy backlog of electronic orders, and building order books in the chip sector, it may be worth trying MagnaChip in your portfolio.