Has the market for computer components been irreparably damaged by the rise of mobile devices and their displacement of desktop and laptop computers? If the answer is yes, then the low valuations of many component makers may be justified. If the answer is no, then many of them may make for very compelling value investments.
Micron Predicts a Long-Term Recovery
Micron Technology (MU) has decided to decrease the price of its memory-chips, but insists that this price cut is only temporary. In an interview, Chief Executive Officer Mark Durcan stated, "It's a short-term issue. If we see any reasonable macro environment this thing sorts itself out pretty quickly." Micron made this pricing decision based on forecasts of deteriorating demand at the end of this year. A price-cutting strategy in this season is particularly dismal because the holiday season is usually a sales generating season for the memory-chip industry.
Micron's president, Mark Adams, said that the price of NAND flash memory increased more than company's expectation and DRAM prices have dropped on lower demand and higher supply.
Micron is also attempting to bet on a long-term recovery by expanding its production capacity through acquisition. Regarding the acquisition of bankrupt Elpida Memory, Mark Durcan foresees that the deal would be closed in the first half of the next year. In July, Micron offered $2.55 billion to acquire the bankrupt Japanese computer memory chips manufacturing company.
Today's Reality: Component Markets are Plummeting
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 component-making equipment.
The tech sector is recoiling from the third quarter's blow to personal computer sales. PC sales worldwide declined 8.3% as compared to the last year's third quarter sales according to Gartner Inc.'s market research. Gartner's 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."
Trouble at the Top
One sign of industry turmoil is hastened executives exits. Advanced Micro Devices (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.
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.
Component Ecosystem Shakeup
The bad news doesn't end with component 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 (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 $30-33 billion, lower than previous estimates of $32-35 billion. The company's forecast for its own sales in its fiscal fourth quarter was lower than those estimated by analysts.
Are there any PC component firms that offer compelling value?
Shares of Micron Technology are not trading low enough at $5.50 to compensate investors for the risks. At a value of 0.67, this stock trades at a fraction of the S&P price-to-sales average multiple. Micron shares are trading at an incalculable price-to-earnings ratio (there was net loss for the last twelve months). The 0.72 price-to-book multiple of this stock is very attractive, much cheaper than the 2.07 S&P 500 average. Investors should consider the price-to-book ratio of Micron to be even lower because the price-to-book ratio fails to account for internally-developed intellectual property, including patents, brands, and trademarks. If the economic value of these assets were even partially recorded on the balance sheet, the firm's price-to-book ratio would be lower.
Not all component makers are as cheaply valued as Micron. For example, the severity of the disruption in the tech sector has not yet landed for Applied Materials' stock. The shareholders of this semiconductor equipment & materials industry large-cap stock have seen a 3.5% rise in price over the past year and it now trades near $11. The firm's 1.45 price-to-sales ratio and 13.06 price-to-earnings ratio do not signify an appropriate discount since it is in line with today's prevailing market multiples.
Other component stocks offer more risk than Micron while also offering lower valuations. After 60% drop in price over the past year, Advanced Micro Devices' shares afford speculators an attractively-priced betting opportunity to speculate at $2 a share. When compared to the 1.32 price-to-sales ratio of the S&P 500, the 0.24 ratio of this stock is very attractive. Advanced Micro Devices shares are trading at an incalculable price-to-earnings ratio (there was net loss for the last twelve months). Investors should be concerned that the firm's assets are financed almost two thirds by debt. This indicates that AMD shares are speculative.
In contrast, less speculative income investors can find dividend yields at reasonable prices by buying shares of Intel (INTC) at $21 per share price levels. This stock pays a hefty 4.23% dividend which is more than twice the 1.82% 10-year Treasury yield. Future dividend payments are likely because the company pays out 0.34 of earnings as dividends, so earnings could drop considerably before dividends must be cut. The firm does not have a weak balance sheet and carries a reasonable 0.15 debt-to-equity ratio, demonstrating that the firm is not overleveraged.
Intel is also trading at appropriate valuations given its future outlook. The firm's 1.95 price-to-sales ratio is in line with today's prevailing market multiples. Intel Corporation shares are valued at a compelling 9.01 price-to-earnings ratio, a value which is significantly lower than the 14.23 average of the S&P 500.
These are tough times for PC component makers. However, bleak industry scenarios are common settings for savvy value investments. In particular, Intel provides an attractive income investment opportunity. Instead of choosing shares of Micron, investors should consider shares of Intel. Micron's management could be in denial about the state of the tech sector, and its appetite for acquisitions should concern investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.