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The Semiconductor sector may be overheated, but these 2 semi stocks look like bargains

The Semiconductor sector may be overheated, but these 2 semi stocks look like bargains

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One of the interesting storylines this week has been the status of semiconductor the sector. The general opinion of most analysts point to the fact that this sector has outperformed the market throughout the current bull market’s run. Consider that since finding a bottom in late 2008 at around $23 per share, the iShares PHLX Semiconductor Sector ETF (SOXX) has increased in value to a close today at $183.95 per share – a ten-year total return of nearly 700%! That clearly outperformed when compared to the S&P 500, which has “only” returned about 500% after it found its bear market bottom in early 2009.

The really interesting part of the sector’s performance has been the way it mostly defied the market throughout the most of the year. Like most industries, semiconductors entered correction territory in late January and early February, dropping more than 10%. But while the broad market mostly staggered and struggled to find any significant momentum from that point, semiconductors managed to rally back and hit a new high in late March. After dropping back again on a temporary basis, the sector rallied back to that high in the $195 area in the last week of May. That put the sector’s gain for the year at about 11.5%, while the S&P 500 was actually about 2% lower for the same period.

Trade war rumors and fears have had their way with the sector since the first week of June; as of today’s close the sector is down almost 6%, while the S&P 500 actually rallied, posting a gain of a little over 2% over the same period. That reversal of fortunes has led some analysts to predict the run is over for semiconductors; and the truth is that there are a lot of stocks trading at exaggerated multiple of most standard measurements of a stock’s “intrinsic value.” There are some interesting exceptions to the rule, however, and I’ve identified three semiconductor stocks that I think bear watching more closely.

If the sector’s weakness over the last two months continues, I would expect these stocks to get dragged down along with the rest. However, there are always individualized cases of stocks that defy their industry or sector’s performance, and either one of the stocks below have a reasonable case to make for why they may hold up better than most of their brethren. Even if the sector does take them down along with it, at some point down the road the sector will come back into favor with the rest of the market; when it does, these two stocks should stand above the rest and should offer an even bigger opportunity than they do today.

Micron Technology (MU)

Current Price: $51.37

Micron Technology, Inc. (MU) is engaged in semiconductor systems. The Company’s portfolio of memory technologies, including dynamic random-access memory (DRAM), negative-AND (NAND) Flash and NOR Flash are the basis for solid-state drives, modules, multi-chip packages and other system solutions. Its business segments include Compute and Networking Business Unit (CNBU), which includes memory products sold into compute, networking, graphics and cloud server markets; Mobile Business Unit (MBU), which includes memory products sold into smartphone, tablet and other mobile-device markets; Storage Business Unit (SBU), which includes memory products sold into enterprise, client, cloud and removable storage markets, and SBU also includes products sold to Intel through its Intel/Micron Flash Technology (IMFT) joint venture, and Embedded Business Unit (EBU), which includes memory products sold into automotive, industrial, connected home and consumer electronics markets.

MU has a terrific fundamental profile, with earnings that more than doubled over the past year, and revenues that grew over the same period more than 40%. They have an excellent financial base to work from, with healthy operating margins and more than $1.3 billion more cash and liquid assets than long-term debt. The stock’s Book Value has also more than doubled since the beginning of 2017, from $12 per share to $25.45 at the end of May. Despite the stock’s terrific fundamentals, the sector’s weakness has played itself out in MU’s performance; the stock is down about 17.8% from the all-time highs it reached in late May.

At the stock’s current price, it is trading at a Price/Book multiple of 2.01, which is only slightly below its historical Price/Book ratio of 2.26. That isn’t very compelling, but comparing the stock’s current Price/Cash Flow ratio of 4.1 to its 3-year historical average of 5 is. That suggests the stock has both room and reason to revisit its all-time highs in the $62 to $63 range.

Applied Materials, Inc. (AMAT)

Current Price: $48.13

Applied Materials, Inc. provides manufacturing equipment, services and software to the global semiconductor, display and related industries. The Company’s segments are Semiconductor Systems, which includes semiconductor capital equipment for etch, rapid thermal processing, deposition, chemical mechanical planarization, metrology and inspection, wafer packaging, and ion implantation; Applied Global Services, which provides integrated solutions to optimize equipment and fab performance and productivity; Display and Adjacent Markets, which includes products for manufacturing liquid crystal displays, organic light-emitting diodes, upgrades and roll-to-roll Web coating systems and other display technologies for televisions, personal computers, smart phones and other consumer-oriented devices, and Corporate and Other segment, which includes revenues from products, as well as costs of products sold for fabricating solar photovoltaic cells and modules, and certain operating expenses.

AMAT is an interesting company, because they provide the equipment semiconductor companies all over the world use to manufacture semiconductor chips. That means that companies like Intel Corp (INTC), Texas Instruments (TXN), and MU, to name just a few, make up AMAT’s customer base. The company also boasts manageable, conservative debt levels relative to available cash, and excellent ongoing cash flow from operating margins that are well above the industry average. One of the areas where AMAT diverges from the strength I just outlined for MU is in its Book Value; this number dropped almost 14% in the last quarter to only $6.99 per share. AMAT actually topped out in mid-March at almost $62 per share, and is now down about 22% from that point.

At the stock’s current price, it is trading at a Price/Book multiple of 6.88, compared to a historical average of only 4.06. Most analysts would stop there, saying the stock is clearly overvalued. I think that while there is some risk the stock could drop further, there are some really good reasons to suggest the stock is actually undervalued right now. For one, the stock’s Price/Earnings ratio is only 12.08 right now, while its historical average is around 20. It is also trading almost 22% below its historical Price/Cash Flow average, which clearly suggests that if the stock can build some bullish momentum, it could revisit its all-time highs above $60 per share.

Should you jump into these stocks right now? Perhaps not; the exposure to sector risk appears pretty elevated right now. If you’re interested in looking for an entry point into the Semiconductor sector when it moves back into favor, and that risk is minimized, however, these are two of the stocks that you would be smart to think about working with first.

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