Wedbush Morgan analysts Craig Berger and James Schneider initiated coverage on Atmel (ATML) with a buy rating and $6.50 target price. Highlights from their note to clients:
• Despite ATML’s run from around $2 in Q3’05 to current levels over $5.00, we think the company’s prospects for margin expansion and cost reduction, as well as healthy overall industry dynamics, will provide tailwinds to the stock over the coming months. Longer term, we see additional opportunities for cost reduction as the company has significant room to trim higher-cost manufacturing facilities and outsource the manufacturing of more of its commodity product lines.
• Atmel has recently announced a series of restructuring activities aimed at lowering costs, including headcount reductions, fab closures, and outsourced manufacturing. We think Atmel can increase gross margins by at least +5 points to 35% over the next year, while continuing to trim OpEx to more sustainable levels. We expect gross margins could rise an additional +2-3 points if management gets more aggressive about cutting costs further in its manufacturing
• We believe ongoing process shrinks and cost improvements in Atmel’s highly competitive memory, ASIC, and microcontroller businesses will outpace the rate of price declines in the broader market through 2006. We believe Atmel can reduce its cost basis in ASICs and memory by 30-35% on a blended basis in 2006 versus likely 20-30% annual price declines. We see as much as +3-4% of total gross margin upside if the company can execute on its process shrinks in a timely fashion.
• Our channel checks show that Atmel recently implemented price increases at distributors on the consumer, wireless communications, and industrial markets, each of which remains strong or seems poised for a recovery this year. We think the company’s heavy exposure to high-volume commodity products, while not a sustaining positive, will likely provide some short-term benefits as competitors in the broader semiconductor business are seeing lean inventories and thus robust pricing trends.
• Given Atmel’s depressed earnings power, its valuation on a 2006 EPS basis is not very meaningful at 39x our estimate. However, we think the company’s valuation is more compelling on a 2006 EV/Sales (1.3x) or a calendar 2007 P/E basis (14x). Given the company’s opportunities for restructuring and cost reduction, as well as very healthy overall industry dynamics, we see upside in the stock to $6.50 per share, which is 18x our 2007 EPS
estimate, or a 1.6x multiple of 2006 EV/Sales.
ATML 1-yr Chart