Chips, No Dip: Why Fed Should Leave Rates, And Taking Cover In Chip Stocks

This week the spotlight will fall on two people who have the power to determine which way the markets will head, and who will be making headlines simultaneously.

First up will be Federal Reserve Board Chairman Ben S. Bernanke with the announcement on the interest rate, whose actual wording will be critical, at 9:15pm, Israel time. Two hours later, Cisco Systems Inc. (CSCO) CEO John Chambers will be holding a conference call at which he will be unveiling his company's second quarter results.

While Wall Street guru James Cramer has been "screaming" in near desperation at Bernanke to get real and lower the interest rate, I feel, on the other hand, that if it does come down, the stocks markets will collapse together with the dollar, since such a decision will signal panic and the onset of a severe recession. Investors want to believe that the credit problem is under control, and that it is limited to those banks that engaged in the provision of risky mortgages, or hedge funds that got wiped out after they took the wrong direction. We haven't heard anything of late about hedge funds making a lot of money because they all gambled on the collapse of the subprime market.

For me, the ideal scenario this evening, one that would trigger a strong rally in the US equities market, is one where the interest rate is left on hold, with the Federal Reserve Open Market Committee's statement stressing that the battle against inflation still remains a top priority for the central bank (and not the fear of a financial crisis), and that the US economy is enjoying a reasonable rate of growth, thanks to the rapid rate of global growth. This forecast will, hopefully, get an endorsement from the field two hours later in the form of the Cisco CEO himself, who will shift investors' focus back to the thriving global technology markets.

Twice a year, Citigroup publishes a review of all the various tech stock niches, and yesterday saw the release of the first two in a series of reviews on chip and chip manufacturing equipment stocks. In December 2006, it set a one-year target of 550 points for the Philadelphia Semiconductor Index [SOXX], and yesterday it raised this to 560 points, despite the recent market slide, following which it corrected to 488 points as of yesterday morning.

Citigroup advises investors, now that there are increasing fears of an impeding financial crisis, to take cover in several chip stocks, which, they feel, look like a fairly attractive investment for the rest of the year. Among the list of recommended US stocks are Intel Corporation (INTC), Spansion Inc. (SPSN), Micron Technology (MU), Marvell Technology Group (MRVL), ON Semiconductor Corp. (ONNN), and SanDisk Corporation (SNDK). Citigroup feels that we have once again reached a situation that occurs every few years, during which the rate of investment in chip production infrastructure declines, and history has shown that is worth entering chip stocks when the industry reaches this juncture.

Of the above list, and among the stocks I have in my portfolio, Citigroup analyst Craig Ellis covers two, SanDisk and Marvell. He rates both companies "Buy" with a target price of $71 for SanDisk and $23 for Marvell, which in recent days has plummeted, yet again, to less than $17, after reaching a high for the year of $20 on the back of rumors that a number of private equity funds are mulling a bid for the company, together with its controlling shareholders.

The drop in Marvell's stock price was caused by the market, and also by CIBC, which swapped its ratings, upgrading the company's rival, Broadcom Corp. (BRCM) and downgrading Marvell. In addition, the company surprised options players when it announced that it would unveil its results on August 23, a week later than they thought, and beyond the date of the expiry of the August options that many people acquired as bet on the likelihood of good guidance and/or a company sale.

Ellis believes that Marvell will fare better in the second half of the year, with 2008 likely to be exceptionally strong. He believes that it can double its operating margins by the end of 2007, and triple them by the end of 2008, which leads him to also believe that the stock will undergo a strong rally toward the end of year, reversing the disappointment that investors have been feeling of late. Ellis believes that Marvell will have a major growth engine in the wireless chips that are being integrated in the iPhone, and in computer games, digital cameras, and printers.

Ellis sees further growth for Marvell in its high-speed Ethernet communications chip business and, primarily, the new business that it acquired from Intel last year - cellular handset processors. It has one mega customer for this - Research In Motion Ltd. (RIMM), which has been galloping full speed ahead thanks to the success of its Blackberry wireless platform, in addition to several other major customers in the form of Taiwanese secondary manufacturers of advanced cellular handsets. Citigroup believes that the computer market will grow by 12% over 2006, during which it was at standstill, and consequently, it feels that hard drive storage chips, one of Marvell's leading businesses, is also likely to see renewed growth in the coming quarters.

As for SanDisk, Ellis continues to recommend it aggressively, since he feels, among other things, that the recent data indicates that the analysts, himself included, will soon find themselves revising upward their 2007 royalty estimates for SanDisk yet again. Put in numbers, the revised figure will now be $455 million, instead of Ellis' current forecast of $438 million, and the company's own guidance of just $425 million.

The increase in prices in the NAND chip market is the factor that will yield more royalties for SanDisk, and these, as is known, go straight into the profit line. This increase has been caused by, among other things, production setbacks at Hynix Semiconductor, shutdowns at Samsung plants last week due to technical faults, and higher demand in general.

The "Wall Street Journal" reported yesterday that Hynix and SanDisk had agreed to set up their first jointly owned fab, with CEO Dr. Eli Harari quoted as saying "we'll produce something similar to NAND." Harari could, perhaps, be referring to msystems' x4 chips, on which the two companies signed a collaboration agreement before msystems was acquired by SanDisk, and which Harari later renewed after the merger was completed.

Published originally by Globes [online], Israel business news - www.globes.co.il
© Copyright of Globes Publisher Itonut (1983) Ltd. 2006. Republished on Seeking Alpha with full permission.

Comments

[Bill Islava]

Although I found Mr. Cohen's article interesting, he has been proven flat wrong. A shame because I thought he was right on and have paid dearly in the markets. A bummer!!