If any subsector in technology is cyclical, it is the semiconductors. Toss in a massive trade dispute that has really muddied the waters for the chip stocks over the past year, and many investors have decided that the risks are just too great. The reality is that despite the numerous daunting issues the semiconductors have encountered, the Philadelphia Semiconductor Index (SOX) has traded in a bounded range for over six months and looks to be breaking out of a quadruple top pattern.
While the technical data may give some investors more comfort, the bottom line is that while earnings could be solid for the third quarter, fourth-quarter guidance could be sluggish, and that could take its toll on the sector.
In a set of new research reports, the Merrill Lynch analysts make the case that semiconductor stocks could move higher on solid earnings, seasonal strength and hopes for a 2020 recovery. They also point out that from 2010 to 2018, the fourth-quarter and first-quarter returns for the SOX index returned 19% versus 2% for the S&P 500.
The analysts have four large cap companies selected as top picks, and all make sense for aggressive growth accounts looking to add alpha over the next six months and beyond.
This stock could very well continue to benefit from an increase in information technology and upcoming 5G spending. Analog Devices Inc. (NASDAQ: ADI) is a leader in the design, manufacture and marketing of analog, mixed-signal and digital signal-processing integrated circuits for use in industrial, automotive, consumer and communication markets worldwide. It offers signal-processing products that convert, condition and process real-world phenomena, such as temperature, pressure, sound, light, speed and motion, into electrical signals.
The company has among the best end-market exposure, with high communications and aerospace/defense market exposure, in addition to offering investors a powerful 5G content growth story. Plus, acquisitions over the past few years like Linear Technology and Hittite Microwave should provide revenue and additional cost synergies that are still coming.
Investors receive a 1.95% dividend. The Merrill Lynch price target for the stock is $130, and the Wall Street consensus target is $117.77. The stock closed Wednesday trading at $110.59 per share.
This sector leader made a huge purchase in the spring. Nvidia Corp. (NASDAQ: NVDA), a company that rarely has grown through acquisitions, bought Mellanox and paid a whopping $6.9 billion in cash. The deal has come under some scrutiny lately as some feel that the trade war and other issues could sidetrack the transaction, but for now it is still on.
Mellanox’s BlueField intelligent network adapters are another version of data center co-processing acceleration. Top Wall Street analysts see the combination of Nvidia and Mellanox as a definite threat to Intel’s data center CPU dominance of workloads. This indirect competition could ultimately be a problem for Intel shareholders.
Merrill Lynch feels that the third quarter could provide a solid print but note that fourth-quarter guidance, weak global growth and trade issues are still an overhang for the company.
Investors receive a 0.33% dividend. The $250 Merrill Lynch price target compares with the $193.10 consensus target. Shares closed Wednesday at $194.21.
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This is still considered a top play for investors looking for a chip stock with Internet of Things (IoT) exposure, and it is a member of the Merrill Lynch US 1 list. NXP Semiconductors N.V. (NASDAQ: NXPI) became the fourth largest semiconductor company in the industry after it merged with Freescale in late 2015. It is also important to note that the combined company is the number one supplier in auto semiconductors with a 14% share, as well as the number one supplier in global microcontrollers and a dominant supplier in mobile payments.
NXP continues getting its chips into high-growth areas such as contactless mobile payments, the Internet of Things, mobile phone charging, increased cellular data consumption and even LED lighting. With shares trading at a solid discount to peers, some Wall Street analysts are very positive on the faster earnings growth potential relative to its competition.
Merrill Lynch has a $125 price target, while the consensus target is $117.77. Shares closed Wednesday at $108.61.
This classic old-school chip tech company offers solid value at current levels and is a great pick for more conservative investors. Texas Instruments Inc. (NASDAQ: TXN) is a broad-based supplier of semiconductor components, ranging from digital signal processors to high-performance analog components, to digital light-processing technology and calculators.
Some 65% of the company’s sales are exposed to the well-diversified, business-to-business industrial, automotive, communications infrastructure and enterprise markets. While the stock was hit hard recently as it is a big Apple supplier, the long-term outlook for this venerable leader makes it a safer bet for accounts with less risk tolerance.
In addition, the shift toward a parallel processing and IoT computing paradigm translates to secular demand growth for the company’s integrated circuits sold into IoT devices, which will ship in the tens of billions of units. Continued consolidation of analog industry translates to better pricing and higher gross margins, and the firm’s superior cost structure should translate to higher gross margins and share gains.
Investors receive a 2.78% dividend. Merrill Lynch has set a $150 price target. The consensus target is $129.37, and shares closed at $129.50.I'm interested in the Newsletter
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These four large-cap stocks have the potential to post solid third-quarter results. While fourth-quarter guidance could rock the boat some, it is important to remember the seasonal outperformance of the sector over the past decade.
GOAL IS SMOOTH
For the most part, analysts seemed to be sidelined on International Business Machines Corp. (NYSE: IBM) after it released its third-quarter financial results after the markets closed on Wednesday. But they see a light at the end of the tunnel.
24/7 Wall St. has included some highlights from the earnings report, as well as what analysts are saying after the fact.
IBM did manage to exceed analyst expectations with a third-quarter profit of $2.68 per share, outside of items. The results beat the Refinitiv consensus estimate of $2.67 per share. Its net income fell to $1.87 per share ($1.67 billion) from $2.94 per share ($2.69 billion) a year ago.
IBM’s total revenue fell by almost 4% to $18.03 billion in the third quarter, short of the consensus estimate of $18.22 billion. The company did indicate that revenues would have dropped by only 0.6%, excluding the impact from currencies and business divestitures. Unfortunately, IBM’s new businesses and strategic imperatives just are not able to offset the old core businesses fast enough to move the needle for IBM to be considered attractive to investors who want growth.
In a post-acquisition world with Red Hat under the IBM umbrella, the company hopes to (and needs to) grow its subscription and recurring revenues. IBM’s technology services unit showed a 5.6% drop to $6.70 billion in the quarter. Here is how its growth segments performed after adjusting for currencies: Revenue for Red Hat was up 20%, Cloud & Cognitive Software was up 8% and Cloud revenue was up 14%.
Credit Suisse reiterated an Outperform rating with a $173 price target. The firm said that IBM is continuing to center on the return to sustained revenue growth. Credit Suisse thinks that inflection starts in the fourth quarter, with an early boost from mainframe before passing the baton to Red Hat and the related pull-through of “core” IBM in 2020. Indeed, early progress on Red Hat is encouraging and Credit Suisse continues to believe the acquisition significantly improves IBM’s standing in the rapid push toward hybrid cloud.
Merrill Lynch reiterated a Buy rating with a $170 price target. The firm offered this investment rationale:
We view IBM as a defensive investment given its high exposure to recurring sales, cost cutting levers, solid balance sheet, potential share gains, and relatively stable margins. We believe IBM will embark on further cost cutting, and enhance its services and software offerings through acquisitions. Longer term, we expect IBM to take share in IT spending with its Cloud and AI initiatives.
Here’s what a few other analysts had to say:
Wells Fargo reiterated a Market Perform rating and lowered its price target to $140 from $147.
BMO reiterated a Market Perform rating and lowered its price target from $157 to $152.
Wedbush reiterated a Neutral rating and cut its target price to $155 from $165.
CFRA reiterated a Buy rating with a $165 price target.
Nomura Instinet reiterated a Buy rating and cut its target to $170 from $175.
Shares of IBM traded down 6% on Thursday to $133.66, in a 52-week range of $105.94 to $152.95. The consensus price target is $153.05.
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Apparently, Fiat Chrysler Automobiles N.V. (NYSE: FCAU) and PSA Group, owner of Peugeot, may merge. This would create the world’s fourth-largest car company and a worthy competitor to Toyota, General Motors and Volkswagen, which rule the industry. Among the manufacturers left out would be troubled Ford Motor Co., (NYSE: F) the second-largest American operation. General Motors Co. (NYSE: GM) would certainly find Ford a strong partner as the industry consolidation continues.
The reasons for consolidation seem compelling. Manufacturing capacity among the car companies has become overbuilt. Combinations would kill some redundancies, which has to be part of the reason PSA and Fiat Chrysler may marry. The redundancies also include people. The global economy faces another recession, probably in the next year. If car companies learned anything in the last recession, it is that a sharp drop in car buyers can ruin a manufacturer.
Among the most important parts of any consolidation is the chance to combine product development, which is more complex and costly with the advent of advanced vehicle technology, including electric and autonomous cars. Ford management already has signaled an $11 billion restructuring, which has barely begun, to streamline costs and prepare for a future in which gasoline-powered cars begin to disappear.ADVERTISEMENT
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Another attractive reason for consolidation is having a footprint in the largest markets, primarily the United States, China and Europe. PSA and Fiat Chrysler would have a chance to challenge leader Volkswagen in Europe. Fiat Chrysler would give the combined company substantial market share in the United States via its Jeep and Chrysler brands. Neither company has a dominant position in China, the world’s largest car market.
The challenges of global market share, manufacturing capacity issues and product development costs have plagued Ford under its new management, led by CEO James Hackett, who has been a disappointment, and Executive Chairman William Clay Ford Jr., whose family still steers Ford. GM’s CEO Mary Teresa Barra, on the other hand, has shown herself to be adroit, smart and willing to make hard decisions. The most recent of these was ending a UAW strike that cost GM about $3 billion.
Ford and GM certainly have overlapping costs that have to be in the billions of dollars. Together, they would have about 30% of the U.S. market. They would be much less dominant in Europe, which GM has exited, but where Ford still has a presence. GM and Volkswagen are the largest manufacturers in China. Ford’s efforts there have been a catastrophe. No global car company can have long-term success without a major presence in the world’s largest car market.
Ford has made a major commitment to electric and autonomous vehicles. Management says the company will have 40 electric vehicles by 2022, an audacious claim. GM has to go down the same path. Together, they would face every other large manufacturer, as well as Tesla and tech companies like Alphabet (owner of Google), which has its own self-driving division: Waymo.
Investors have signaled their worry about both GM and Ford. GM’s market cap is $55 billion and Ford’s is $34 billion. On the other hand, Toyota’s is $198 billion. Future risk concerns are baked into these figures.
The Ford family ultimately will decide whether the company can be bought out by or merge with GM. Their own self-interests may be served by tethering their weak manufacturer to one that is much larger. In fact, over time, they may not have a choice. GM would allow Ford “ownership” to stay in the United States, instead of going to Japan, Europe or South Korea.
Challenges to a Ford and GM merger include aggressive unions and, perhaps, the U.S. government. If the future represents the kind of risk the two companies must see on their horizons, they will be willing to weather those to have a pole position in the global market.