This Sector Beat All Others in 2017. Don't Expect a Repeat, Analysts Say

• December 22 2017
• Jeran Wittenstein

Don’t expect a repeat of this year’s market-leading performance for semiconductor stocks.

Don’t expect a repeat of this year’s market-leading performance for semiconductor stocks.

Despite a recent sell-off, the Philadelphia Semiconductor Index is up 92 percent since the beginning of 2016 and is poised to beat all 11 S&P sectors for a second consecutive year, fueled by earnings growth and an unprecedented period of consolidation. While the streak hasn’t quite turned analysts bearish, some are advising investors to be selective with their picks and vigilant for signs of slowing demand and rising inventory levels. Here’s a look at what analysts are saying about 2018.

Morgan Stanley

• “Exceptional” growth in 2017 brings “mild concerns” about inventory, supply acceleration and double ordering in 2018, which should have a “more mixed environment” though some opportunities remain
• Strong conditions always carry signs of expanding customer inventories and those signs usually don’t become a negative for stocks until there’s a reversal, which isn’t expected “at least early in the year” given solid demand
• Still, investors should be prudent in looking for a more mixed environment, such as lower growth forecasts, signs that the memory market is becoming “less universally robust” or moderation in what has been a "strong" period of capital spending
• Current conditions continue to warrant “market weight” exposure and recommended stocks include ASML Holdings NV, Xilinx Inc., Ambarella Inc., Win Semiconductors Corp., Analog Devices Inc., TE Connectivity Ltd, Micron Technology Inc., Applied Materials Inc. and Lam Research Corp.

Oppenheimer

• The semiconductor "upcycle" that began in 2016 is somewhere in the “late middle innings”
• The advance in semiconductor shares over the past 18 months has caused multiples to expand while increasing investor sensitivity to any indications of weakening demand or excess inventories
• At this stage, stock picking is “critical” and Oppenheimer continues to favor stocks that offer consistent, above-average growth, free cash flow and shareholder returns
• Top growth picks are Monolithic Power Systems Inc., Skyworks Solutions Inc. and Semtech Corp., while favored free cash flow growth and return plays are Broadcom Ltd, Analog Devices, Texas Instruments Inc. and Marvell Technology Group Ltd

Bloomberg Intelligence

• Chipmakers’ 2017 gains -- driven in part by strong earnings growth and a conducive backdrop for mergers and acquisitions -- are unlikely to be repeated in 2018
• Acquisitions and potential for earnings growth remain, but multi-year-high multiples may have less room to expand
• Auto and industrial chip content growth remains a secular story, and 2018’s memory pricing may remain strong, contingent on phone demand
• U.S. tax and cash repatriation policy changes could aid earnings

Bernstein

• It’s unlikely that 2018 growth will be as strong as 2017 but the semiconductor sector will be fine as long as the demand cycle continues; in this environment, investors should own stocks with “structural or secular components to the story” that can work well in a cyclically strong environment and potentially offer some relative protection if the market turns
• Broadcom remains top pick going into 2018; even if the company isn’t successful in acquiring Qualcomm Inc., Broadcom still has room for organic growth, margin expansion and a substantially higher dividend
• Texas Instruments isn’t “sexy” but it is poised to “grind higher” over time and the company is set to benefit more from lower corporate tax rates than anyone else in Bernstein’s U.S. semiconductor coverage
• Nvidia Corp.’s market opportunity is somewhere between “big” and “huge” despite an “intimidating” valuation; investor perception of the company’s opportunities is likely to become more positive over time

Stifel

• Continues to be bullish for 2018 on semiconductor capital equipment companies and believes recent pullback in shares represents a buying opportunity
• On 3D NAND front, companies such as Samsung, Toshiba and Intel appear to be on schedule for first half 2018 shipments, deliveries and installations, potentially laying groundwork for record shipment activity over the next quarter
• Despite broader concerns about memory pricing, checks suggest no slowdown in equipment activity while suppliers see demand continuing to outpace supply in 2018 even with new capacity coming online
• Top picks include Applied Materials and MKS Instruments Inc.; Lam Research and FormFactor Inc. should continue to benefit from memory exposure and outperform in 2018