Morgan Stanley: Semiconductor sector hits rock bottom

Morgan Stanley: Semiconductor sector hits rock bottom
Morgan Stanley: Semiconductor sector hits rock bottom – Morgan Stanley (NYSE:) said on Wednesday that shipments of analog and microcontroller units (MCU) in the semiconductor sector bottomed out in the second quarter.

In the past, recognizing this fundamental bottom has led to outperformance. This time, however, stocks bottomed out eight months ago when companies indicated that a “final pullback” was imminent, so Analog Devices are now trading at a 50% premium to historical averages, analysts say.

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“We are moving to a mid-cycle playbook and a selective approach, although we remain positive on the cohort due to the positive correlation between under-distribution and 12-month returns,” they wrote in a note.

Analysts believe that while the multiples are justified, they do not expect outstanding performance in this cycle.

They are looking at two key issues: generating alpha in an upswing, which in the past has been achieved through structural business improvements or above-industry revenue growth while maintaining stable margins. This time, they see no candidates that meet those criteria, according to the Morgan Stanley team.

In addition, they look at the justification of the multiples and find that Analog trades at a 50% multiple premium to history, which seems reasonable given the margin expansion and consolidation during the cycle.

As multiples rise, analysts expect estimate revisions to drive returns. In the past, consensus estimates have tended to underestimate both up and down cycles, leaving room for revisions.

The analysts are now taking a more selective approach and are upgrading Microchip Technology (NASDAQ:) to “Equal Weight” and ON Semiconductor (NASDAQ:) to “Underweight”.

“We believe MCHP’s valuation reflects inflated expectations, while a deeper bottom with a cumbersome balance sheet will slow the pace of deleveraging,” the analysts said.

“ON is facing sales declines in auto semiconductors, SiC and image sensors, which is clouding our margin view, so we see limited scope for multiple expansion,” they added.

Shares of MCHP and ON fell more than 2% and 3%, respectively, in premarket trading.

Morgan Stanley maintains an Overweight rating on Analog Devices (NASDAQ:) as its relatively higher ASP products should limit competition with emerging Chinese capacity and its revenue outlook is strong with a book-to-bill ratio above 1 in all end markets.

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