Chip Bulls See Second-Half Comeback After Shaky 2018 Start

(Bloomberg) -- In a year that’s seen cold water thrown on some of the hottest trades, it may pay to stick with semiconductors.

Chip stocks -- among the top performers in the past two years -- had a volatile start to the year, as some market watchers had predicted. But analysts including MKM’s Ruben Roy see them moving higher in the second half, citing strong demand from data center, automotive and industrial customers and compelling valuations.

“We continue to believe that attractively valued names, with upcoming growth catalysts” are worth buying, Roy said in a research note last month. His top picks include Broadcom Inc., Marvell Technology Group and ON Semiconductor Corp.

The Philadelphia Semiconductor Index has erased double-digit percentage gains twice this year as investors try to make sense of conflicting trends including U.S.-China trade tensions, continued strength in data-center demand and lackluster smartphone sales. The gauge is up 9 percent year-to-date, thanks to big increases from companies like Micron Technology Inc. and Nvidia Corp. The S&P 500 Information Technology Index, aided by companies such as Twitter Inc. and Adobe Systems Inc., is up 14 percent.

The Philadelphia Semiconductor Index rose 0.5 percent at 10 a.m. in New York to extend a four-day gain, its longest winning streak in more than a month. Analysts’ price targets for the 30 stocks in the chip index imply a 16 percent increase over the next 12 months, according to data compiled by Bloomberg. That compares with a 9 percent increase projected for the broader S&P tech gauge, which includes 72 companies.

“Semiconductor stocks sort of fit our overarching theme about being a little more value oriented,” Jefferies strategist Steven DeSanctis said in a phone interview.

While sentiment surrounding software and Internet stocks is “off the charts,” semiconductor companies are less of a momentum trade, DeSanctis said. Last month, he downgraded his recommendation on small- and mid-cap technology stocks to market weight from overweight. U.S.-focused stocks with compelling valuations are likely to fare better for the remainder of the year, he said.

A forecast boost from Intel Corp. last month and continued strength in memory pricing should help fuel a 15 percent increase in revenue to $476 billion for the group in 2018, up from previous expectations for a 12 percent gain, Morgan Stanley analysts Joseph Moore and Craig Hettenbach said in a note last week. Selectivity is increasingly important and companies with “unique value or growth drivers” such as Nvidia, Broadcom, Analog Devices Inc. and Xilinx Inc. will fare better, Moore and Hettenbach said.

Nvidia, up 30 percent this year, has been aided by a continued processor-buying binge by data-center owners. The company’s data-center revenue rose 71 percent to $701 million in the first quarter. Memory maker Micron, which announced a $10 billion share repurchase plan in May, is benefiting from similar demand trends and has gained 35 percent.

Not all indicators are flashing bullish signs. Benchmark analyst Gary Mobley last month said he’s concerned about high levels of electronic component inventory “at most points in the supply chain.”

Notable exceptions to optimism are semiconductor equipment makers including Applied Materials Inc. and Lam Research Corp., which have lagged in the past month. Applied Materials is down 9 percent so far this year, and Lam Research has fallen about 4 percent.

“Equipment names did really well in 2016 and 2017,” Mehdi Hosseini, a Susquehanna Financial Group analyst, said in an interview. “Now, since we don’t really know how their customers are going to change their investment plans, people have taken profits.”

Hosseini expects equipment spending to remain weak until the second half of 2019, but he still has a positive rating on both stocks in anticipation of a rebound.

Chip-equipment makers and materials suppliers including Applied Materials and Entegris Inc. will gather Tuesday in San Francisco for the annual Semicon West conference. The memory-chip market and U.S.-China trade relations will be key topics of discussion, according to Cowen analyst Krish Sankar.

“Next year will be another growth year for WFE,” Sankar said, referring to wafer fabrication equipment. “But it appears some investors aren’t fully convinced.”

©2018 Bloomberg L.P.

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