2 Risky Semiconductors, 1 Defensive Stock
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Semiconductors constitute some of my favorite stocks on the Street. Lam Research (NASDAQ: LRCX), for example, is well positioned following its merger with NVLS. The integration will help unlock meaningful cost synergies while enabling Lam to gain market share on Intel. Management has stated that the company will see $100 million worth of cost synergies by Q4 2013, but I believe revenue synergies will be significant given minimal product overlap.
Overall, consolidation is likely to continue in the industry, creating a few winners and many losers. Lam's decision to increase scale through this merger will enable it to have greater pricing power and thus better margins. Asia checks have illustrated health NAND but weak DRAM trends. Capital expenditures are still a crap shoot with Taiwan Semiconductor looking to be aggressive in a 28nm production ramp as other foundries stay relatively conservative. Strong order trends for NAND customers, including Samsung, will take away some of the attention in poor momentum elsewhere. Most firms are reserved on capacity expansion in DRAM, which is likely to see a 15% y-o-y decline in spending.
Applied Materials (NASDAQ: AMAT) has shown similarly strong execution. Consensus estimates forecast Applied's EPS declining by 27% to $0.94 in 2012 and then growing by 19.1% and 11.6% in the following two years. This far exceeds the weighted average cost of capital and will result in strong value creation. Overall, it is cheaper than Lam on a PE basis and thus represents more of a value play. Less transformative takeover activity, however, may make the company potentially vulnerable to being locked out of the market.
The semiconductor industry has shown signs of life recently. Applied's last fiscal year may have shown weak operations, but releases from major brands like Amazon, Apple, and Microsoft will provide strong end markets that are currently underappreciated by investors. And while I believe Lam's takeover was more accretive, I am optimistic about the long-term fruits of Applied's takeover of Varian. The upside is within the range of 8% and will benefit from greater display spending in this half of the year.
For safety, however, Texas Instruments (NASDAQ: TXN) is always a strong bet. I like the firm's renewed interest in higher-margin segments, like embedded chips and analogs. Acquisitions of cheap technology will enable the firm to realize the greatest bang for its buck and thus generate high returns on invested capital.
While the decision to exit wireless baseband chips may limit top-line momentum, the fast growing smartphone and tablet markets will both generate solid business for Texas Instruments from the processor market. High profile design wins should remind investors about why brand is everything in semiconductors. Accordingly, I recommend buying a defensive stake against riskier firms Lam and Applied.
