The Decline in Chip Stocks Offers a Buying Opportunity

Investors have overreacted to the slight month-over-month drop in semiconductor sales for February. Those interested in chip stocks should use the drop to gain fresh entry points.

Apr 8, 2014 at 12:45PM

Shares of leading chip manufacturers have been selling off after the Semiconductor Industry Association released a mixed report for February. Worldwide chip sales for the month came in at 25.9%, which represented 11.4% year-over-year growth, but there was also a 0.3% decline from January sales. The historical month-over-month sales increase going from January to February is usually around 2.2%.

Shares of flash memory manufacturer Micron Technology (NASDAQ:MU) have been the hardest hit, tumbling 4.2% just a day after the firm delivered a glowing second-quarter fiscal 2014 report showing that it managed to beat both the consensus top- and bottom-line estimates by a good margin.

Altera (NASDAQ:ALTR) shares have fallen by a comparable margin, shedding 4.1%, while Xilinx (NASDAQ:XLNX) shares have fallen 2.62%. Analog-chip maker Texas Instruments' (NASDAQ:TXN) shares are down 2.83%. The broader Philadelphia Semiconductor Index shed 2.7%, compared with the Nasdaq's 2.63% fall.

Meanwhile, things are looking up
The semiconductor industry put up a stellar performance in 2013, finishing with record sales of $305.6 billion, representing 4.8% year-over-year growth. The sector has gotten off to an encouraging start in fiscal 2014, with the slight sales decline countered by a 2% increase in chip prices across the board.

The overall outlook for the semiconductor industry this year remains bright, with Christopher Danley of J.P. Morgan predicting that industrywide sales growth in 2014 will outpace last year's impressive 4.1 % growth. According to him, the industry could grow by as much as 8%, with the programmable-chip subsector outperforming its flash-memory and microprocessor brethren. That implies that programmable-chip manufacturers such as Xilinx and Altera might see better top-line growth than flash manufacturers such as Micron Technology.

Xilinx manufactures the popular 28-nanometer programmable chips that customers can program and run on various low-power applications. The new chips clocked $100 million in sales for the company in the last quarter, or almost 20% of its overall sales. The firm sells to large companies such as Cisco and China Mobile. With such large customers, growth seems assured at the moment.

The company expects to capture 70% of the 28-nm chip market in the current quarter and sell 28-nm chips worth $250 million for fiscal 2014. The company's new product portfolio grew by a blistering 80% during the last quarter, and now accounts for 40% of overall company sales. That's a sign of a truly innovative company.

Xilinx is looking to capitalize on China Mobile's ongoing LTE build-out in China. Forrester's Bryan Wang suggests that Xilinx 28-nm programmable chips might be a cheaper alternative for China Mobile to use than the older chips. If China Mobile decides to use them, then Xilinx might soon see a huge growth in 28-nm chip demand.

Meanwhile, Altera, one of Xilinx's chief competitors, recently entered into a new expanded agreement with Intel (NASDAQ:INTC), which will use "multi-die" technology to manufacture Stratix 10 programmable chips for Altera. The multi-die technology involves combining memory chips, programmable chips, and processors into customized devices.

This novel production technique will lower production costs considerably for Altera. In addition, the company will benefit from using Intel's state-of-the-art 14-nm trigate transistor technology, and help it to compete favorably with Xilinx's 16-nm chips.

Both Xilinx and Altera can benefit from the still-nascent Internet of Things, or IoT, that's being touted as the biggest thing to happen since the Internet itself. The IoT will, quite likely, lead to a a data boom that will in turn demand more robust cloud networks to support it. Cisco recently announced its plan to build a giant federated Intercloud as it gears up for the IoT. Xilinx has a strong partnership with Cisco, and the latter awarded it with the 2013 Supply Chain Security Champion award last year. This could mean more business for Xilinx from the networking giant.

New-look Texas Instruments looks promising
Texas Instruments is the giant of the space. The company's product portfolio consists of high-performance analog and power management circuits, as well as high-volume and logic components. The company caters to more than 80,000 customers within the computing, telecom infrastructure, wireless, and automotive industries.

Texas Instruments took a bold decision to exit the low-margin wireless business in 2012. The decision has proved to be the right one, since the firm's net income jumped 23% in fiscal 2013, with its gross margin improving 230 basis points to 52%. The company's improved bottom line helped it increase its dividend payout by 40% last year.

Investors have been happy about the company's progress, and its shares shot up 50% last year.

Bottom line
The overall outlook for the semiconductor industry remains good despite the February blip. Investors can use the recent sell-off of the shares of leading players to gain fresh entry points.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems and owns shares of China Mobile. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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