I find that my expertise as a supply chain management consultant helps me a great deal with my investing strategy.
These days, a lot of brokerages — Morgan Stanley, Salamon Smith Barney, and Prudential to name a few — are getting excited about the semi-conductor “sector”.
I put the word sector in quotes because, as I have opined before, I believe it is illogical to apply the word to a group of companies that have similar manufacturing processes, but serve a number of different vertical markets, or true sectors.
The two biggest sectors served by semiconductor manufacturers are the personal computer sector (including servers, desktops, laptops, and peripherals) and the telecommunications sector.
I find it absolutely amazing that brokerages continue to cover semis as a free-standing sector, as if they had independent demand and could recover without a recovery first at the top levels of the supply chain. In case you haven’t noticed, nobody is saying anything good about Compaq, Dell, and HP right now, least of all HP’s own CEO Carly Fiorina, who recently warned on the third quarter and now predicts a global slowdown in demand. And IBM’s growth is in the services area, which doesn’t drive demand down to the semis.
In the telecommunications industry, the only predictions for revisions in capital expenditures are in one direction — downward.
Now I understand that the market is an anticipatory animal, and that stock prices reflect hope and expectations for the future. I really, really do. But you can’t have hope for companies at level 5 in a supply chain until you have hope for a recovery for companies at the top of the supply chain, and nothing has changed there as of yet. I would be buying semis when I hear Michael Dell, John Chambers and John Roth say that demand is really starting to pick up, or when I see carriers increase their capex budgets. Because six months later, the benefits will trickle down the supply chain to the semis. But as of yet, there is nothing to trickle down. Nada. Zippo. Zilch. Unless you count statements that CEO’s hope things will improve in the second half of the year. But these are statements of hope, not statements of increased visibility.
Now it’s true that semis can rebound prior to a recovery at the top of the supply chain. For one thing, many semis were oversold, and there are enough semis with good earnings and single digit P/E’s to illustrate that point. For another thing, semis will experience a rebound in demand when inventory gets worked out of the supply chain and new orders start trickling in. But that will be a brief, one time pop. Real growth will not return at the bottom of the supply chain until real growth returns to the top of the supply chain. This ain’t rocket science, folks.
Of course, a lot depends on your definition of recovery. In June of this month, Broadcom, for example, is down 87% from its 52 week high. It could double from here and still be down 74% off its 52 week high. So if you are moving fresh money into techs, you might consider a 100% increase in the price of Broadcom to be a substantial recovery. But if you’re holding onto shares you bought near the high, I doubt that you will be feeling much better when Broadcom is “only” 74% off of that high.
But it just sickens me to hear grown men analyze a pseudo-sector as if it can recover independent of its customers. If these analysts really believe that the semis are in recovery mode, they should be touting the likes of Nortel, Alcatel, Dell, and HP stock right now, because a recovery there will presage a recovery in the semi “sector”. And they’re not doing that. And that makes them either liars, idiots, manipulators, or at best, optimists. Or perhaps their definition of a recovery is different from mine. Perhaps they are just celebrating the possibility that Broadcom might go from 36 to 45 in the next twelve months and they are calling that a recovery. But in my book you don’t wipe out trillions of dollars of wealth, give back a few lousy billion, and call it a recovery. You don’t watch a stock double off a bottom that is lower than a nuclear bunker and call that a recovery.
Now I am not disputing that a bottom is in for the semis and for the market in general. I don’t dispute that things will get better over the next 12 months. What I am disputing is the manner in which the recovery will play out. The market crashed from the top of the supply chain down. It will recover in the same sequence — from the top of the supply chain down — not from the bottom up. And to hear analysts upgrade the bottom without first upgrading the top makes no sense to me.
It seems that there are a couple of analysts that agree with me:
“We encourage investors to take a long, hard look at the supply chain and end demand before buying Intel on a PC-recovery scenario,” says Merrill Lynch first vice president Joseph Osha, in a research note published this week.
and
The Semiconductor Industry Association bolstered that viewpoint on Wednesday. The trade group said that, though it expected a net downturn in demand for chips this year, it sees an industrywide recovery getting under way in the second half of this year and extending through the end of 2003.That’s a comforting message, all right, but it might be a bit on the wishful side, according to Dan Scovel, an analyst with Needham & Company.
“Fundamentally, if you look at what’s going on in the industry, business conditions remain very weak,” he said.
“We’re seeing a lot of folks chanting the mantra about a stronger second half,” he added. “But the problem is, [chip companies] don’t have the customer orders, they don’t have the backlog waiting, they don’t have confident forecasts from customers, they really don’t have the data points or the hard evidence, so, in our view, there’s still a material amount of risk here.”
But I am not jaded. I am not without hope. My hope is that the telecommunications industry will recover faster than predicted, just as it crashed faster than most people predicted. My hope is rooted in three things, as I have pointed out in previous columns:
Lower interest rates will enable telecoms to refinance debt and take on additional debt.
Telecoms are enjoying pricing power for broadband services, which leads to increased revenue streams. Many ISP’s have raised prices recently by an average of 15% (Bellsouth, Roadrunner, Earthlink, and AOL to name a few.) The increased revenue should facilitate more capital spending.
By all accounts, demand for bandwidth continues unabated and shortages are imminent. In fact, I believe I have been personally impacted by a bandwidth shortage. My readers may recall the major e-mail problems I had recently for over a month. According to my sources, the root cause of the problem was insufficient bandwidth — Charter’s bandwidth provider was oversubscribed. That explains why my e-mail problems were intermittent — one second I could connect to the server, and the next second I could not. There wasn’t enough bandwidth to handle the load. It took Charter a month to find another carrier capable of supplying the necessary bandwidth. Think about that when you go to sleep tonight.
But please, people — look for real signs of a recovery at the top of the supply chain before you buy stocks at the bottom. And if you want to buy purely on faith and hope — before there are any tangible signs of a recovery anywhere in the supply chain, buy at the top of the supply chain — not the bottom.
