Chip Stocks That Could Sink With PC Sales

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 |  Includes: AMAT, AMD, INTC, SPY, TER, VSH
by: Dividend Kings

Today many industries in the tech sector are in value territory. This fall from grace is apparent in how the firms of the SPDR Technology Selector Fund (NYSEARCA:XLK) trade at an average 15 price-to-earnings ratio which is only slightly higher than the 14 price-to-earnings ratio of the S&P 500 (NYSEARCA:SPY) fund companies. Many familiar semiconductor names trade at even lower valuations. Apparently, tech is no longer the darling of investors and the sector has nearly the same valuations as the broader stock market.

Investors can seize the opportunity offered by the market today by reviewing the challenges faced by different semiconductor stocks that are priced as value investments. In particular, semiconductor manufacturers and their suppliers are frequently trading at attractive multiples in today's markets. Are they value investments or value traps?

PC Sales Slide

The tech sector is recoiling from the third quarter's blow to personal computer sales. PC sales worldwide declined 8.3% compared with the last year's third-quarter sales, according to Gartner Inc. market research.

Gartner head analyst Mikako Kitagawa said, "The overall PC market decline was triggered by a continuing slowdown in PC shipments," and that the outlook for the launch of Microsoft Windows 8 is tenuous because "shipments were less vigorous as vendors and their channel partners liquidated inventory in the third quarter."

Retailers resisted placing orders because of the weak back-to-school sales. These firms had cleared out their entire inventory before the launch of Windows 8. In contrast, the professional market remained unaffected.

Trouble at the Top

As often happens amid industry turmoil, executives are leaving or being replaced. Advanced Micro Devices's (NASDAQ:AMD) CFO Thomas Seifert announced he will be leaving the company. Though Seifert had only been with the company for three years, he had the longest tenure of any C-level executive at the troubled company

While all PC makers and PC component makers are feeling the blow from the rise in popularity of tablets and smartphones, analysts say that Advanced Micro Devices is particularly vulnerable because of internal execution problems as well. In July the board had to take dramatic measures after underperforming in both China and the European market.

Seifert had been chosen as the temporary CEO after the removal of Dirk Meyer from the position. Meyer was reportedly pushed out after the company failed to successfully integrate into the growing mobile and smartphone market. The new CEO Rory Read's arrival has confirmed Seifert's decision to leave and was followed by the resignation of several respected, top engineers and senior executives. Those close to Seifert within the company cited that one of his reasons for leaving was to seek a permanent position as a CEO.

A CFO leaving is usually bad. It often marks the refusal to acquiesce to CEO pressures for aggressive accounting. In this case, there is a believable backstory about Seifert being passed over and facing an effective demotion to a second-fiddle position. Even if this truly was his motivation for leaving, the next CFO can use the regime change as an excuse to "clean house" by aggressively recognizing losses and delaying sales recognition for future quarters while blaming it on the old CFO. Such earnings management is more common when a new CEO takes the reigns, which is also happening at Advanced Micro Devices.

Component Ecosystem Shakeup

The bad news doesn't end with chip makers. Weak PC sales are being passed through to companies that provide component-making equipment. First, personal computer sales suffered, sending shocks throughout the companies which contribute to the industry. Lower PC demand reduced revenue for computer distributors. The distributors responded by lowering component orders. Component manufacturers such as chip-makers respond to lower sales by slashing budgets for new equipment used to make computer chips.

Applied Materials (NASDAQ:AMAT) is such a company, and this major producer of chip-making equipment plans to reduce its workforce by 9 percent. This measure could reduce headcount by 900 to 1300 employees while saving $140 to 190 million per year.

Applied Materials has reduced its industry-wide factory-equipment sales guidance to $30 to $33 billion, lower than previous estimates of $32 to $35 billion. The company's forecast for its own sales in its fiscal fourth quarter was lower than those estimated by analysts.

The earnings of Applied Materials can act as a barometer of electronics industry optimism. According to market researchers, the PC market will grow by less than 1 percent in 2012, which forecasts the worst market in 10 years. This would translate to slower orders for PC components and could prompt companies like Intel (NASDAQ:INTC) to reduce spending. Intel is one of Applied Materials' major customers and is expected to announce declining sales.

Reconciling Valuations

Are there any chip makers in the value chain that offer compelling value? Consider the following financial metrics:

Ticker

Company

Semiconductor Industry

P/E

P/S

P/FCF

D/E

AMAT

Applied Materials

Equipment & Materials

13.13

1.46

8.9

0.23

AMD

Advanced Micro Devices

Broad Line

0.3

5.7

1.81

ATML

Atmel

Broad Line

12.78

1.31

16.86

0

ENTG

Entegris

Equipment & Materials

10.35

1.5

11.46

0

INTC

Intel

Broad Line

9.1

1.97

20.59

0.15

TER

Teradyne

Equipment & Materials

9.39

1.61

15.39

0.1

VECO

Veeco Instruments

Equipment & Materials

10.93

1.53

20.47

0

VSH

Vishay Intertechnology

Broad Line

8.77

0.53

9.77

0.29

Click to enlarge

Without profit over the past year price-to-sales and price-to-free cash flow multiples bear out that Advanced Micro Devices is cheap among its peers. Investors should be concerned that the assets are financed almost two-thirds by debt. This indicates that Advanced Micro Devices shares are speculative.

Hard times at Applied Materials are also baked into its share price, making it cheaper than other semiconductor equipment and materials stocks based on price-to-sales and price-to-free cash flow metrics. Unlike Advanced Micro Devices, debt levels at Applied Materials are no cause for concern.

Intel, Teradyne (NYSE:TER), and Vishay Intertechnology (NYSE:VSH) offer the most value on the basis of earnings. These earnings multiples would be unthinkable during the tech bubble. Vishay in particular trades at very, very low multiples across the board.

Conclusion

Without a doubt these are tough times for semiconductor firms. However, bleak industry scenarios are common settings for savvy value investments. In particular, Intel, Teradyne, and Vishay offer attractive price multiples at recent prices. They are trading at low valuations yet have very strong balance sheets with little debt.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.