Semiconductors: Rotation Within Sector From Growth to Value Provides Pair Trading Opportunities

by: Joe Kunkle

Semiconductors have lagged the recent market rally as the group faces pricing and demand concerns after a strong growth cycle wanes. The group is only 5% off its recent lows, while the market is around 10% off its recent lows. Often seen as the leadership group in the larger Technology sector, semiconductors have given way to Business Software, Storage, and Cloud Computing, and are about to see a rotation within the sector, from growth to value.

Recently, I have seen option traders targeting the outperforming names within the semiconductor group with put options, betting on downside in the growth names that have fared better than the majority of the group, while buying upside call options in the names that are beaten down and offer compelling values on P/E, P/S, and P/FCF metrics.

The names that have seen a surge in put buying recently include Broadcom (BRCM), Altera (NASDAQ:ALTR), Xilinx (NASDAQ:XLNX), Teradyne (NYSE:TER), Analog Devices (NASDAQ:ADI), Lam Research (NASDAQ:LRCX), Cavium Networks (CAVM), Novellus (NASDAQ:NVLS-OLD), Maxim Integrated (NASDAQ:MXIM), National Semi (NYSE:NSM), TriQuint (TQNT) and Atheros (NASDAQ:ATHR).

On the other side of the spectrum the names seeing bullish call buying include Atmel (NASDAQ:ATML), Integrated Devices (NASDAQ:IDTI), Form Factor (NASDAQ:FORM), Intel (NASDAQ:INTC), Marvell Tech (NASDAQ:MRVL), and Amkor Tech (NASDAQ:AMKR).

The upcoming movement can also be seen in recent price action, the reaction to positive news. Altera came out with strong guidance at its mid-quarter update and shares barely budged higher, actually going into the red much of the day. On the other hand, Texas Instruments (NYSE:TXN) provided guidance in line and announced a dividend increase and share buyback, and shares climbed nearly 10% in a few days.

One way to trade this sector rotation is via pairs trading, being long the beaten down value names with money flowing in, and being short the names that have outperformed and are priced on growth expectations, and are likely to see money flowing out.

Here are 4 ideas, looking at each of the semiconductor sub-sectors, and leaving out memory chips because that group is in for a world of hurt with the lack of end user demands and extremely weak pricing on over-supply.

Semiconductor Broad Line:

Long Intersil Corp (NASDAQ:ISIL) and Short Analog Devices (ADI)

Intersil shares trade 10.1X earnings, 1.8X sales, and 18.2X cash flow while Analog Devices trades 11.7X earnings, 3.5X sales, and 16.3X cash flow. Intersil has rounded out a rounded bottom and trades near early 2009 levels, while Analog Devices is not far off 2 year highs.

Semiconductor Equipment and Materials:

Long Kulicke & Soffa Industries (NASDAQ:KLIC) and Short EZchip Semi (EZCH)

Kulicke & Soffa shares trade 3.1X forward earnings, 0.64X sales, PEG of 0.24, and 7.6X free cash flow, while EZchip Semi trades 17.25X earnings, 12.15X sales, and 7.6X cash value. EZchip shares are trading near 2007 highs that could act as a double top, while Kulicke shares are near 1 year lows but are holding trend support off the prior bottoms.

Semiconductor - Integrated Circuits:

Long Marvell Tech (MRVL) and Short Semtech (NASDAQ:SMTC)

Marvell shares trade 10.2X earnings, PEG of 0.88, 3.4X sales and 11.9X cash flow, while Semtech shares trade 10.35X earning, PEG of 5.3, 3.08X sales, and 16.5X cash flow. Marvell shares are more than 20% off April highs, while Semtech is trading less than 10% off its April highs.

Semiconductor - Specialized:

Long Lattice Semi (NASDAQ:LSCC) and Short Altera Corp (ALTR)

Lattice Semi shares trade 9X earnings, PEG of 0.9, 2.1X sales and 5.4X cash flow, while Altera trades 12.5X earnings, PEG of 1.1, 5.8X sales, and 14.9X cash flow. Altera shares are trading near levels last seen in 2001, while Lattice Semi shares are near 5 month lows, and more than 20% off April highs.

These are a few ideas to take advantage of a shift that is about to take place in this sector, and a movement towards value being favored over growth as uncertainty in the sector continues.

Disclosure: Currently Own Broadcom (BRCM) Put Options