Four Strong Semiconductor Stocks

Fortunes within the semiconductor industry seem to be looking up, to a certain extent. We were interested in finding out from Zacks senior semiconductor industry analyst Ken Nagy, CFA where he felt some of the strongest Buys in the space are, currently.

Where do you see buying opportunities within your semiconductor sector coverage?

Over the past month or so, we have issued Buy reports on four companies: Tessera (TSRA), Intellon (ITLN), O2Micro (OIIM) and Ultra-Clean (UCTT). All of these companies supply to original equipment manufacturers (OEMs), or are OEMs themselves, for the semiconductor industry.

Not necessarily household names, however.

Well, but that’s because they do not have big market caps. But they all stand to benefit from the ongoing resurgence within the semiconductor upcycle.

Tessera’s advanced packaging technologies, for instance, have industry-wide application. Its licensing business has very attractive operating leverage characteristics. Also, the firm has won five major lawsuits and now receives royalties from all of the big four in the DRAM (memory) market: Samsung, Micron (MU), Infineon (IFX) and Hynix. The company has licensing agreements with Samsung and Hynix, which together have almost a 50% market share.

The stock is currently trading at a 13.7x multiple of our 2009 earnings estimate (P/E). Considering the company’s market strength, we expect solid revenue and earnings growth to continue. The company receives royalty on approximately 80% of the DRAM market, which should be a catalyst going forward.

Because this company is involved in lots of copyright litigation, doesn’t this create additional risks?

We acknowledge concerns over increased litigation costs and the potential for large swings in revenue caused by large irregular settlement payments, but these concerns have created this attractive entry point in the share price. We would be more concerned with rising litigation costs if the company were not winning most of the cases.

We recommend the purchase of this stock for investors that have a time horizon greater than two quarters. We are reiterating our target price of $35.00, which represents a 22.7x P/E.

Tell us a little about Intellon.

Intellon Corporation is a fabless semiconductor company that designs, develops, manufactures, and markets integrated circuits (ICs) for power-line communications or high-speed communications over existing electrical wiring. Its ICs enable home connectivity, which is the sharing and moving of content among personal computers and other consumer electronics products in the home.

Margins are trending up and we see the string of quarterly losses ending in the second half of 2008. We upgraded these shares to a Buy on May 26th of this year, with a price target of $8.00.

What about O2Micro?

O2Micro has a strong position in the notebook computing market and a growing position in the LCD monitor and LCD TV markets. Management has focused investments into these new vertical markets, attempting to broaden its product portfolio.

The LCD TV markets represent an opportunity to grow its revenue base and boost margins to the low sixties. We also recently upgraded this company to a Buy recommendation. The company is headquartered in the Cayman Islands, and 70% of the firm’s 530 employees work outside the United States, primarily in Japan, China, Taiwan and Singapore.

And the last company you mentioned was Ultra Clean. I’ll guess it has little to do with janitorial work.

A correct assumption! Ultra Clean is a supplier of gas panels to semiconductor manufacturing OEMs. The company is expanding its product line to include frame assemblies, top plate assemblies and process modules. The Seiger acquisition is progressing seamlessly and the company is transitioning several product lines to Shanghai. This has the effect of diversifying the revenue base as well as growing margins.

The company’s diversification into non-gas panel revenue is encouraging. Long-term growth is highly leveraged to the success of the new non-gas panel business. We believe that the stock will outgrow the semiconductor industry and trade above the current valuation metrics. Consequently, we are setting a target price of $13.00, which corresponds to a 14.6x P/E multiple.

Ken Nagy, CFA is a senior analyst covering the semiconductor industry for Zacks Equity Research.

Comments

[Ishortyou:]

Nice report, thank you for the feedback

2008 Jun 24 09:21 AM

[Ames Tiedeman:]

This was a well written piece. Better than many. Thanks!

2008 Jul 09 06:30 PM

[netxformer:]

Anyone betting on small-time Powerline companies like Intellon these days has obviously not been following the news about G.hn or the latest wireless technologies, WiMAX, LTE and other 4G technologies. The time has long passed for startups in this space; the Big Boys (TI, Intel, Sony, Motorola, and many others) as well telcos like AT&T, FT-Orange, DT, and Verizon, and a host of other standards bodies (esp. the ITU) are behind standards-tracked HomeGrid, not the proprietary HomePlug Power Line Technology.

This former standard (G.hn/HomeGrid) will displace all the disparate and separate media-based technologies (HomePlug, MoCA, HomePNA) with a single worldwide standard, supported by major semiconductor manufacturers. The startups had their chance and they blew it. I know, I was in one of them (Intellon), but could not prevent them from botching their lead in this area, despite having written the standard for HomePlug in the DSL (now Broadband) Forum.

"Too little, too late", for the likes of Intellon and the others in this Powerline space is what will be said in their obituary this time next year. They're going out with a whimper, and no one will even notice.

2008 Jul 27 04:04 AM