* Semi sell off, MCHP part two or a bigger deal this time around?
Semi & SPE stocks sold off sharply on 3/25 (SOX down 4.6% vs. S&P down 1.5%) with weakness attributed to TSM’s comments at a conference. TSM stated that customer inventory is now elevated due to FX-related disruptions in demand, and also noted that it expects to save several hundred million due to equipment reuse (vs. 2015 capex guidance of $11.5- $12.0 bn). We believe the key question is whether this sell off is a buying opportunity similar to MCHP’s negative preannouncement in October (when the SOX declined 11% before rallying 25% through year-end) or the start of a more protracted downturn in semi fundamentals and the stocks.
* We highlight important differences between March 2015 and October 2014.
1) TSM is an industry bellwether, and its comments on fundamentalweakness came less than two weeks after a negative preannouncement by Intel (another bellwether). While Microchip is an important company in the MCU segment, this segment is relatively narrow vs. the broader industry.
2) Many semis cut numbers for 4Q but no others supported the view of an industry correction. This enabled investors to buy the dip with the belief that the semi fundamental upturn was intact (contrary to our view).
* The direction of stocks from here: In order for investors to have the confidence to buy this dip aggressively, we believe several bellwethers will need to assure investors that fundamentals are intact during the upcoming earnings season (in ~2-3 weeks). We have discussed this cycle that the majority of semi stock performance has been driven by multiple expansion (rather than estimate increases), with a few notable exceptions (Exhibit 1). We believe the market has justified multiple expansion based on the view that semis are no longer cyclical. As a result, we expect that protracted fundamental weakness would likely drive severe multiple contraction and we reiterate our Cautious sector rating on Semis.
* What about semi equipment? As occurred in Oct. 2014, SPE stocks got caught up in cautious semis news flow. We do not believe TSM’s comments on equipment reuse warranted a sell off in SPE stocks (LRCX down 7.6%) but
believe investors were also reacting to market debate concerning Samsung’s memory wafer capacity and an anticipated Intel capex cut to offset the cash flow impact of its revenue shortfall. Similar to October (when we used the sell off in LRCX as an opportunity to add the stock to the CL), we see the current sell off as overdone in the context of the impact to Lam’s actual fundamentals and we would be buying LRCX on the weakness.