Q: When is it the correct time to buy into a cyclical stock/company/industry ?
A: The correct time to nibble is when the leading company is losing money – while the second and third tier companies have NO pricing power. The clear time to buy more is when pricing power returns to the industry – through consolidation, or evolution, or by companies abandoning the industry.
Keeping in mind the above, it is time now to start nibbling at semiconductor stocks. In the semiconductor industry, there is one clear leader – Intel. Then, there is everybody else. Sure, some companies have a limited ability to price their products at levels wherein they make a reasonable amount of money; in prior articles, I talked about Linear Technology (LLTC) and Maxim (MXIM) – each with gross margins in excess of 70%, and then, about ARM Holdings (ARMH) – whose gross margins exceed 85%.
But each of these companies have their respective problems. In the case of Linear, it is the inability of the company to grow its sales. Maxim was [until recently] tainted by a serious allegation of back-dating options; and ARM has a lag of five years from new product release to the time when they receive even a dime in royalties [I am talking about their processors that account for over 80% of revenues].
My criteria for picking semiconductor stocks are based on:
a. Gross margins.
b. Debt to equity ratio.
c. Competitive position (product/technology), pricing power [subjective].
d. Management (subjective).
e. Cost structure (technology dependent).
f. Valuation – especially price/sales ratio (dependent on a and c).
Keeping in mind that I do not use automated screens [though I sometimes do that as an after-thought], I focus on companies that I know and am familiar with. The finalists are:
1. SanDisk. SNDK is the best run Flash memory company. #1 Company – Samsung is not really analyzable as it is a conglomerate, and their numbers are not subject to SEC filings. The only chink in SanDisk’s armor is their off-balance sheet liabilities outlined in paragraph two and three of the SanDisk/Samsung article that I published in the recent past. Add $6.5 Billion to SNDK’s current enterprise value of $2.25 Billion (at $10/share), we end up with $8.75 Billion.
In the last three months, SNDK had negative gross margins on the sale of products. In fact, it was a negative 17.5%. In the trailing nine months, SNDK’s product gross margins were +3.3% – fantastic numbers when compared to their competition. I know that SNDK is working aggressively at shifting products to tighter geometries, and are targeting higher-end flash markets – where, while pricing is still weak, SNDK has more pricing power when the memory is packaged as a SSD – for an ultra-light/pricey laptop [think MacBook Air].
I expect Dr. Eli [Harari] & Co. to position SNDK to have positive product gross margins in as quickly as nine months (calendar Q3, 2009) – through the process of migration to tighter geometries; by successfully cramming in more “bits” per cell, and through manufacturing efficiencies. Add to this their stream of royalties, SanDisk’s focus on non-volatile memory (unlike its competitors), and SNDK’s efforts to successfully rein back some smaller competitors in Taiwan, SanDIsk emerges as the clear winner from an investment perspective.
2. nVidia. NVDA competes with the ATI division of AMD, and Intel’s (INTC) own graphics chip division. nVidia’s graphics cards/chips span the entire spectrum of graphics chips from smaller chips for PDA’s and cell-phones – to graphic cards that control multiple large-screen monitors, and have several GigaBytes of on-board GDDR DRAM – that cost as much as $2500 a card!
While the analysts’ average of earnings for the announcement on Nov 6th 2008 is a dozen cents a share, I expect them to earn not more than a nickel a share, and while NVDA was victorious in securing the design-in into all Apple laptops, the gross margins will be below what it was [prior to the quarter when NVDA took a charge for a manufacturing/reliability problem]. This is detailed in a prior article of mine.
NVDA’s financials are pristine, and the current valuation is compelling. With no debt and $3/share in cash, and Jen-Hsun Huang at the helm, I am sanguine about NVDA’s future – though the graphics market is lined with road-kill with once mighty names like Chips & Technologies, S3, Tseng Labs, Cirrus Logic [the first two were acquired cheap]. Even NVDA almost went belly-up, and this is the reason why I think they will survive – despite the competitive nature of the business. Additionally, operating systems are being targeted to use the spare processing capacity of GPU’s [both Apple's Snow Leopard and Windows 7 will target the ability of the GPU and graphics' memory].
3. Silicon Storage Technologies (SSTI) and Spansion (SPSN). While these are at best second tier players in NOR flash [with some exposure to NAND Flash], both companies have positive gross margins, and SSTI in particular has no debt and cash per share of $1.10. SPSN is a case when the valuation of a company is ridiculously low. For a $2.4 Billion/year business with positive gross margins, the only company with a working SONOS Flash chip, and a debt/equity ratio of 1.0 [but managed to refinance the current portion of their debt recently], I could buy out SPSN, and successfully turn it around.
1. Long SSTI, SPSN. Will possibly be long SNDK and NVDA in the near future.
©Bapcha’s Stocks, Nov 4, 2008.