The Chip Rebound Continues

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

Microchip Technology (NASDAQ: MCHP) is getting ready to ramp up production to meet increasing demand in the chip sector. That's good news for companies like Microchip, United Microelectronics (NYSE: UMC), and Taiwan Semiconductor Manufacturing (NYSE: TSM).

A good call

Early in the year, Microchip Technology CEO Steve Sanghi said, “We believe the December quarter was the bottom of this cycle for Microchip...” Almost half way into the year, it looks like he was right. In early June he added, “We expect our inventory to be fully corrected by the end of the June 2013 quarter. Unless we take immediate action, the risk is that our inventory will go too low...”

After using a rotating time off schedule to reduce output, the company is now calling employees back to work. Moreover, it is looking for its facilities to “... prepare to ramp production...” to meet increasing demand.

Back on top

Microchip Technology was spun off from General Instrument in 1989. It is a world leader in microcontrollers, the chips that perform the relatively simple tasks of everyday items like remote controls and microwaves. These are, largely, commodity items. However, to change a chip supplier would require customers to make notable design changes to their products. As such, contracts for these chips tend to be long-term.

Microchip's big business is in the older 8 bit space. While competitors have pushed ahead in the more modern 16 bit and 32 bit areas, Microchip isn't sitting still. Shipments of these chips are increasing rapidly, with its number two industry position in 8 bit chips helping to fund the effort.

The top line contracted in fiscal 2012, but came back strongly in fiscal 2013. Although margins fell sharply, leading to a notable bottom line decline, this isn't unexpected. The company has to support its facilities no matter how many chips it sells. As it begins to ramp up production, however, the top line should head higher and margins should improve. The bottom line should respond quickly.

The shares have been stuck in neutral for a couple of years, so there's still time to jump aboard. Moreover, it has a dividend yield of nearly 4%.

The largest foundry in the world

Taiwan Semiconductor claims to be the world's first dedicated semiconductor foundry and the largest. Foundries make chips, but don't design them. So, research and development dollars are spent on upgrading manufacturing capabilities, a key to success in the space. As the largest industry player, Taiwan Semi has more resources to spend to keep its 14 facilities top notch.

The company's top line fell in 2009, but has grown each year since. The stock, meanwhile, has been trending higher since the end of the 2007 to 2009 recession. The shares yield around 2%, but are most appropriate for momentum investors because of the industry's cyclical nature.

That said, April sales were up 13.5% sequentially from March, with year to date sales through April up 25% year over year. Clearly, good things are starting to take shape, which should help boost the top and bottom lines in the year ahead.

Another issue to keep in mind about Taiwan Semiconductor is that it is trying to branch out into lighting and solar energy. There are clear synergies between these industries and chip making, but jumping into new markets can be costly and difficult.

The second tier

United Microelectronics is among the largest microchip foundries in the world. Although it spends heavily to ensure its factories are cutting edge, new entrants have increased the competitive pressure and hurt United's industry position.

Moreover, while United Microelectronics is a large player, it is still relatively small compared to industry giant Taiwan Semiconductor. So, United remains at a cost disadvantage as it tries to keep up with technology changes. That often leaves it as the second choice, not the first. However, as the chip business recovers, more and more business will flow down to the second choice companies. So, United should see a notable benefit.

In the first-quarter earnings release, CEO Po-Wen Yen noted that "[f]ollowing several months of inventory correction in the semiconductor market, demand has stabilized. With increasing demand led by the communication sector, we anticipate 2Q foundry operating results to improve, with wafer shipments projected to exceed 10% growth."

The top and bottom lines have fallen for two years, but look set to pick up over the near-term. Now could be a good time for aggressive investors to step in. The shares yield around 2.70%.

A rebound is upon us

Recent news from each of the companies above suggest that the chip market is ready to turn upward again. While these stocks aren't right for the faint of heart, more aggressive investors might want to take a look. Foundry giant Taiwan Semi is probably the most conservative name, though Microchip Technology sounds the most positive about the future.

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Reuben Brewer 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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