A Semiconductor Stock Outperforming Its Fundamental Value?

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The November rally has been good for nearly every sector in the market.  Bull economy sensitive sectors, like Consumer Discretionary, have been leading from the front.  But one of the sleeper hit sectors from November has been the semiconductor index.  Semiconductors have been steadily outperforming the Nasdaq 100 for a number months, and show no signs of slowing down.

One stock that has enjoyed solid price growth on excellent volume has been Fairchild Semiconductor International (NYSE: FCS). The stock has had three days in January where the amount of shares traded was up to three times average daily volumes, and on each day the stock finished the day higher.   There would appear to be an attempt on the part of buyers to reassert control after two years of quiet trading.  This followed a stellar period for the stock when it enjoyed a ten-fold increase in price from 2009 to 2011.

The fundamental picture remains a little uncertain.  Net margins have been falling and the company missed on its revenue targets.  In fact, it has missed on ever-decreasing analyst expectations for the last five quarters, although EPS figures have more or less been in-line.  The company remains in cost-cutting mode to offset lower sales and improve cash flow.  However, debt levels are at the lowest in their history, and internal inventory was reduced by $23 million (compared to sales of $333 million). Its auto and mobile sectors performed poorly, but industrial and appliance demand improved during the quarter.  The increase in demand has carried through into Q1, although customers remain focused on the short term horizon.  The company stated that its weak Q4 Auto position will be offset by a "strong backlog position."

Heading into 2013, the company is looking at lower capital spend requirements, which will significantly reduce expenditures.  On the product front, the company is hoping new developments from its mobile division will reap rewards, but it was unclear how this would overcome weak demand within the mobile sector.   On further probing, tangible improvements in the mobile division were not expected until the third, or indeed, fourth quarter.  And it was one of their two large ($100 million) customers that appeared to be dragging mobile figures down.  The company provides chips for the iPad Mini and fourth gen iPad,  so could it be that Apple is rocking the earnings ship?  Where it's likely to have more success is in its industrial and appliance business, which it 'under-shipped' by 8% in 2012.  This particular sector is recovering after a run of six weak quarters, so relative gains should be strong in the quarters ahead.

Can Fairchild Semiconductor International glean anything from its rivals?

Within the Integrated Circuits space are three larger rivals: Texas Instruments (NASDAQ: TXN), Broadcom Corporation (NASDAQ: BRCM) and Analog Devices (NASDAQ: ADI).  Whereas Fairchild Semiconductor is susceptible to the whims of its larger customers, the above companies - by sheer size - are far more insulated from the trials and tribulations of individual clients.

All three companies have managed to come in ahead of analyst estimates, with only Analog Devices showing a history of reported underperformance.   However Texas Instruments, the third largest producer of semiconductors in the world, had noted a poor demand environment with limited visibility going forward. Analog Devices experienced revenue declines in Q4 and is expecting those to continue into Q1.  Production was slashed and margins narrowed as the company looks to adjust.  Broadcom is also looking for current quarterly revenue under expectations, although there was a confidence boosting 10% raise in its dividend.  A rise in the dividend is a better sign of future prospects than the current doom-and-gloom around quarterly earnings.

Like Fairchild Semiconductor International, Broadcom also has a strong relationship with Apple, providing Bluetooth and WiFi chips for the iPad and iPad Mini.  However, Broadcom also provides chips for Apple's nemesis, Samsung.  Broadcom's mobile and wireless segment was down a modest 1% in Q4.  In discussing the drop, Broadcom focused on the potential of the new Samsung models, but had little to say about its Apple relationship.  However, it did suggest the mobile earnings miss was likely the result of cannibalization from the provision of chips to different, competing companies.

In a direct P/E comparison, Fairchild Semiconductor International comes in too rich at 78.9, but is likely trading against a far more attractive forward P/E of 13.0.  Broadcom currently trades a P/E of 26.3, with a forward P/E of 10.7.  Texas Instruments offers a more competitive current P/E of 22.2, but a less generous forward P/E of 15.8. Meanwhile Analog Devices has the tightest spread between the P/E's at 20.8 and 17.1.

Demand for Semiconductors.

While the outlook for Q1 remains muted, this should be the time where demand for semiconductors increases.  Seasonal factors usually translate into strong demand for the first part of the year, which gradually worsens through the year, with the exception of mid-Summer.  Deliverable orders peak through the summer and fall sharply in Fall. While companies remain cautious on Q1, this should be the one which offers the best chance for an upward surprise.

Outlook

Looking forward, Fairchild Semiconductor International is likely to continue to depend on cost efficiencies and accounting to generate earnings improvements for the first half of 2013. It will probably be the fourth quarter before it's known if there is any tangible growth in its (mobile) business.  Certainly, there is no shortage of negative headlines on the stock, but the strong performers typically climb a wall of worry.  The broader sector is doing well, and this should be enough to see Fairchild Semiconductor International through this rough earnings patch. 


fallond has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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