Analog and microcontroller unit (MCU) shipments in the semiconductor sector are bottoming out in Q2, Morgan Stanley noted Wednesday.
Historically, identifying this fundamental bottom has driven outperformance, however, this time stocks bottomed eight months ago as companies indicated visibility towards a "last cut," and analog names now trade at a 50% premium to historical averages, analysts said.
"We shift to a mid-upcycle playbook and a selective approach, though a positive correlation between undershipping and 12-month returns keeps us positive on the cohort," they wrote in a note.
The analysts believe that while multiples are justified, they do not expect any standout performers this cycle.
They address two key debates: generating alpha in an upcycle, historically achieved through structural business improvements or revenue growth outpacing the industry with stable margins. This time, they see no candidates meeting these criteria, Morgan Stanley’s team said.
Further, they consider the justification of multiples, noting that analog trades at a 50% multiple premium to history, in line with the SOX ETF, which appears reasonable given through-cycle margin expansion and consolidation.
With multiples expanding, analysts expect estimate revisions to drive returns. Historically, consensus estimates have tended to underestimate both up and down cycles, leaving room for revisions.
They now adopt a more selective approach, downgrading Microchip Technology (NASDAQ:MCHP) to Equal Weight and ON Semiconductor (NASDAQ:ON) to Underweight.
"We think MCHP’s valuation reflects lofty expectations, while a deeper trough with a heavy balance sheet will slow the pace of deleveraging,” analysts said.
“ON faces top-line headwinds across auto semi, SiC, and image sensors, tempering our view on margin, hence we see limited room for multiple expansion," they added.
MCHP and ON shares fell more than 2% and 3% in premarket trading, respectively.
Morgan Stanley remains Overweight on Analog Devices (NASDAQ:ADI), saying 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.