Microchip shares poised to rise as inventories fall

Analysts said they expect shares of companies that make microchips to rise in the coming months, as orders increase from customers that were using up inventory in the fourth quarter.

"I am confident that we are shipping less than actual end demand, which is another way of saying we are working down inventories at customers," said Doug Freedman, an analyst at American Technology Research.

"That tends to be the best time to buy semis," Freedman said, adding that he expected chip shares to rise 10 percent to 15 percent in the near term.

The last quarter's results of many microchip companies had failed to live up to their own forecasts and Wall Street expectations, but analysts said the outlooks provided by most firms were more realistic.

The Semiconductor Industry Association expects sales of all kinds of semiconductors, such as computer processors, memory chips and wireless processors for mobile telephones, to grow 10 percent this year to $274 billion, gaining speed from last year's increase of almost 9 percent.

Once mainly reliant on the computer industry, chips have now spread to an ever-widening variety of devices, helping to dampen the sector's notoriously sharp boom-and-bust cycles but also making it harder to predict shifts in the business.

The industry may not have found a single new "killer app," but a number of products, such as high-definition televisions and DVD players, Apple's iPhone, and new video-game consoles, should fuel industry growth this year.

The year "2007 looks like it has quite a number of good drivers for the semiconductor industry," said JoAnne Feeney, a managing director for FTN Midwest Securities.

Freedman upgraded his rating on the semiconductor sector last week to "overweight" from "neutral weight", saying that although shares had rebounded from a July low, they still lagged gains in the broader market.

"I had been sort of positioning to get more aggressive on the space, but couldn't bring myself to because I felt that expectations on the space were too high," Freedman said.

That has changed now that the main issue weighing on the sector--high inventories among customers and distributors--is believed to have come under control.

"The underlying crux of the news flow is that inventory is subsiding and overall inventories are getting better," said Citigroup analyst Glen Yeung.

Overall stockpiles at chipmakers themselves--as opposed to at customers--rose 1.5 percent in the fourth quarter from the third quarter, but that should not affect the broader industry since just five companies accounted for 80 percent of the build-up, Yeung said.

Chipmakers have also reeled in their financial forecasts enough that those goals should be relatively easy to achieve.

The average of the midpoints of first-quarter revenue forecasts by 26 companies was 5.6 percent below the fourth-quarter level, compared with the normal seasonal decline of 1.2 percent, Yeung said.

"Are they more conservative or just more accurate? They were too aggressive last time, so why would they be aggressive this time?" Yeung said.

An example came from Intel last month, when it forecast gross margin to stay at about 50 percent this year, an estimate many analysts said it is almost certain to beat.

A clear catalyst for a chip rally might materialize at a March business update by Texas Instruments, whose breadth of products has increasingly made it a favored proxy for the broader industry.

"If demand stays healthy, semi stocks have a very good shot at making up some ground," said Piper Jaffray analyst Tore Svanberg. "But I think it's going to be a little more gradual. People will track how business is every month."