Chip Sector Strength Expected To Continue Through 2011

The latest earnings reports from semiconductor companies have made a few things clear: Enterprise demand is strong, consumer demand for PCs is fairly weak but recovering, and mobile sales are soaring.

The factors that drove many chip makers to post record results in 2010 also bode well for 2011. Businesses are expected to continue spending on technology, while consumer spending on PCs--which waned in the back half of last year--should rebound over the coming months.

Also likely to drive results this year is the start of new product cycles for many companies, including Intel Corp. (INTC) and Advanced Micro Devices Inc. (AMD), which both recently released chips that combine graphics and computing on a single piece of silicon.

In addition, Microsoft Corp.'s (MSFT) Windows 7 operating system is still gaining traction, and the telecom industry is rolling out 4G networks--two other factors that should drive chip demand.

"It looks like a lot of the pieces of the puzzle are coming together in 2011," Stifel Nicolaus analyst Kevin Cassidy said. "The chip sector is a lot more efficient in this cycle, with inventory and longer lead times adjusted in about three months."

Chip demand dropped off sharply in the wake of the recession, with customers virtually stopping purchases. When economic conditions started to improve demand snapped back, leading many companies, such as Intel, to post record results throughout 2010.

But that strong rebound caused some customers to over-order, afraid the tight supply in the market would make it tough for them to get the products they needed. As a result, the third and fourth quarters of 2010 went through an inventory correction, which companies now are confident is nearing an end.

"During our October and December calls, we said that we believed the slowdown would be both short and shallow," Ron Slaymaker, Texas Instruments Inc. (TXN) vice president of investor relations, said last month. "At this point, we believe the correction is mostly complete."

The company, which makes chips for everything from cellphones to televisions to industrial equipment, said it was able to replenish its inventory levels during the fourth quarter, which should help lead times stay at normal levels in 2011. TI projected first-quarter revenue a little better than the company usually sees.

Intel, AMD and other chip makers also said the first quarter is expected to be to be better than that period's typical sequential declines.

"We are seeing better-than-seasonal demand," said Thomas Seifert, AMD chief financial officer and interim chief executive. "We have a terrific roadmap this year ahead of us."

A lot of the optimism surrounding chip makers is reflected in their stock prices. The Philadelphia Semiconductor Index has risen 47% since the end of August and 10% in 2011 alone. While questions remain how much further shares could go, many analysts say there is still some room for growth.

"To some extent, stocks may be getting a little ahead of themselves in the near term, but in the full year, there could be more upside," Miller Tabak analyst Brendan Furlong said. "2011 is looking better than it was just a couple months ago."

One particular pocket of strength is the smartphone and tablet market, which led wireless chip maker Qualcomm Inc. (QCOM) to sharply boost its forecast for the fiscal year ending in September. Companies exposed to the mobile market have posted some of the strongest stock gains in recent months.

In addition, automotive is seen as another strong area in 2011.

Meanwhile, PC demand is expected to rise from the weaker second half of 2010, with Intel saying the PC market should grow at a low- to mid-teens rate in 2011, excluding tablets.

But investors will be watching closely for indications tablets are hurting PC sales.

"There are some signs that where the (Apple Inc.) iPad has launched, it has had at least a small impact," FBR Capital Markets analyst Craig Berger said. "A theme for 2011 will be how much tablets impact PCs and how many tablets are going to be successful."

To be sure, the economy is still at risk of a slowdown, which would lead to a pullback in chip demand. Also, the rising prices of oil, food and materials could increase costs for the chip makers and cause consumers to spend even less.

But for now, 2011 looks to be another strong year for the industry.

"In 2011, everything gets better," Intel Chief Executive Paul Otellini said last month. "The economy is forecasted to improve. Our product line refreshes from top to bottom and our addressable market expands."

-By Shara Tibken, Dow Jones Newswires; 212-416-2189; shara.tibken@dowjones.com

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