2HRS2GO: Salomon analyst tries calling both ends of chip cycle

Salomon Smith Barney chip analyst Jonathan Joseph made another call against conventional wisdom Wednesday, upgrading a slew of semiconductor stocks in the midst of what's sure to be the sector's worst year in more than a decade.

Joseph, whose upgrades lifted the likes of Micron (NYSE: MU), Intel (Nasdaq: INTC), Xilinx (Nasdaq: XLNX) and Applied Micro Circuits (Nasdaq: AMCC) to double-digit gains in early afternoon trading, predicted the bottom for battered chip stocks is "only months away," though he offered very little specific evidence to back up his bold claim.

In fact, chip stocks are the main reason the Nasdaq composite is up 52 points following yesterday's triple-digit jump.

He raised the entire sector to an "outperform" rating and bumped up leaders such as Micron, Intel and Texas Instruments (NYSE: TXN) to "buy" recommendations largely "based upon anecdotal order and shipment data that is so bad it cannot continue for long, and sector data that suggests a fundamental bottom is only months away."

This call comes just two days after Lehman Brothers analyst Dan Niles cut estimates for Intel, TI and Cypress Semiconductor (NYSE: CY) and predicted total chip sales would fall between 18 percent and 20 percent from 2000's record-breaking level.

"We believe that history does repeat itself and this is definitely worse than 1996, and could be like the mid-80s for semiconductors," Niles wrote in his research report. Niles reminded investors that chip sales plunged a record 17 percent in 1985.

Salomon Smith Barney clients and long-term chip investors should all hope that history does repeat itself considering Joseph was the first of the chip analysts to recommend investors unload their semiconductor holdings back in July 2000, fresh off one of the most prolific runs in the sector's history.

"Though a slowdown in the group may take six to nine months, we see "first mover" evidence of a trend reversal in decelerating industry unit shipments coupled with price declines," Joseph wrote in a research note back on July 5, 2000.

At the time, Joseph downgraded a bunch of the stocks that were instrumental in the sector's phenomenal rally such as Advanced Micro Devices (NYSE: AMD), Silicon Storage Technology (Nasdaq: SSTI) and National Semiconductor (NYSE: NSM).

While Joseph didn't nail the bottom spot on, he came damn close.

AMD, for example, was trading at a split-adjusted price of $37.25 at the time. The stock moved up to $45.97 two weeks later, a 23 percent improvement, but quickly collapsed thereafter and now trades at about $24 a share.

Silicon Storage Technology shares were perched at $27.98 before going to $34.06 in late August 2000, an 18 percent gain. However, its shares are now languishing at around $7 a share.

On average, AMD, Silicon Storage, National Semi, Intel, Applied Materials, Lam Research (Nasdaq: LRCX) and KLA-Tencor (Nasdaq: KLAC)--all big players in this sector--gained another 19.3 percent from the July 5, 2000 call before hitting the wall and losing at least half their value in the next year. And most of those gains occurred within two weeks of the call.

The issue at hand now is whether or not Joseph can pull off the rare feat of calling both the peak and the trough of this highly erratic and cyclical sector.

"I have the utmost respect for Jonathan," said Merrill Lynch analyst Joseph Osha. "But just because you're right once doesn't mean you're going to be right every time."

Osha said that unlike that July 2000 call when there was an absence of good news, this call is a bit riskier because so many of the factors that contributed to the sector's demise are still taking their toll.

"Inventories, particularly for communications chips, are still extremely high," Osha said. "We're still working through a massive over-investment across the board and now we also have a slowing economy."

Osha said chip stocks will likely fall another 20 percent to 30 percent between now and July when the sector finally hits its bottom.

Chris Chaney, an analyst at A.G. Edwards, said that while he tends to agree with Joseph's logic he's not ready to jump back into chip stocks at this point.

"We're still holding off," he said. "We're not as bullish as Salomon Smith Barney right now even though we are seeing a lot of this inventory, especially in the DRAM (dynamic RAM) business, burning off. The bottom probably is nearer than it's been in the past six months."

At first glance, Lehman's Niles and Salomon's Joseph would seem to be at odds considering one is raising ratings on the sector while the other is cutting earnings estimates.

Truth is, they're both saying the same thing just in different ways for different audiences.

"I think Niles is advising those investors who got into these stocks in the past few months to sell into chip rallies like we're seeing today because things are only going to get worse in the second quarter," Chaney said. "Joseph is saying that the bottom is close and investors should either hold the stocks they have or buy a few selective ones in anticipation of a recovery later this year."

Joseph, despite his sweeping upgrades, makes no bones about the fact that sales and earnings for even the biggest chip and chip-equipment makers are going to stink for the next few quarters.

"Never in our experience have we heard stories of prominent semiconductor makers reporting no net bookings in the quarter, shipments for good, if not great, component suppliers falling 50 percent quarter on quarter, and distributors reporting a 65 percent sequential decline in demand," he wrote in the research report.

Now it's up to investors to decide if Joseph's recent success in calling the pinnacle will translate into similar success on the way back up.

And if they think he's right, they should also be prepared to swallow another 20 percent or 30 percent decline just in case he's a bit premature.