3Q Beat and Raise; Cycle Trumps Season
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3Q Beat and Raise. QTD 20 chip companies have positively preannounced
C3Q, increasing aggregate revenue growth from 6.5% to 12.8% q/q; this
compares to 16 in C2Q and 10 in C1Q. Current street ests imply aggregate
q/q growth of 12% in C3Q and an additional 3% in C4Q vs. normal seasonal
of 6.2% and 6.4%, respectively. Channel checks and current booking trends
suggest that companies will beat C3Q and at least maintain current
consensus growth estimates off of a higher base. Chip stocks have
underperformed the last 30 days by more than 500bps, implying some derisking
ahead of earnings. We see 3Q as a positive catalyst against the
more bearish market sentiment. We would highlight INTC as our top large
cap pick, but would also look to own LLTC, MCHP and CY into earnings.
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Cycle Trumps Season. Since 1Q09, semi revenues are up 34% vs. end
market growth of 11% - raising investor concern that restocking is ending.
We monitor 7 tactical indicators for the Cycle: IC Units, Inventory, Utilization
/ Pricing, Capex, and Earnings Revisions – all are still positive. Specifically
we believe investors are too focused on Inventory and not focused enough
on Capex. On Gap: Our analysis indicates that true restocking would drive
semi revenue 30% higher from current run-rate – implying significant upside
to 2010 consensus growth estimates from 13% to 25%. On Capex: Our
analysis indicates 2010 supply growth at ~3.5%, vs. 12% during the 300 mm
transition. In addition, pricing follows utilization – every 100bps of utilization
increase above 90% drives ASPs by a like amount. Lastly our analysis is
somewhat demand agnostic – better consumption only provides upside.
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Structural Dynamics Imply Positive Re-rating. From 1992 thru 2000
semis grew at a 16.6 % CAGR, since the bubble, the Semi CAGR fell to
8.4% - we are arguing that structural growth rates in semis are poised to reaccelerate
to 12% based upon our view that post the 300 mm transition,
tighter structural supply will lead to some re-distribution of inventory through
the supply chain. In 2000 semis were 12% of total tech inventory, in 2008
they were 24% - we believe inventory burden thru the next cycle will more
likely fall between 18-22% - implying cyclically 35% growth from current to
peak revenue and structural an increase in CAGR to 10.4%. We believe as
the market recognizes better topline growth and earnings, semis are likely to
be re-rated - SOX peaked at 9.5% of SPX in 2000, and is 3.1% today.
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Valuation Still Reasonable. Semi stocks still trade at a 25-30% discount to
the prior cyclical peaks on a P/E, EV/Sales and EV/EBITDA basis. This
discount has narrowed from 40% in June but still implies valuation upside as
we approach peak earnings. In fact, for SOX to reach 500 level, or 60%
upside from current, at P/E multiple of 18x, SOX EPS needs to be $27.80,
which is only 3.7% higher than the peak SOX EPS in post-2005 period. 10
out of 18 companies in the SOX have achieved post-2005 peak EPS that is
in aggregate 22% higher than what is “required” of them in order for SOX to
reach 500, based on their index weight.