Take Advantage Of Weakness In Semiconductors, Citigroup Says

In a report published Tuesday, Citigroup analyst Atif Malik commented that investor concern within the semiconductor space continues with a focus on additional capital expenditure cuts on weak PC demand and DRAM oversupply.

Malik reviewed and answered key investor questions:

Will Memory Capex Get Slashed Next Year?

According to Malik, it is unlikely that memory capex will be cut next year. He noted that while PC DRAM pricing has been weak year-to-date on seasonality and higher than average inventories at DRAM supplier, his analysis suggests pricing will have to decline more than 50 percent from current levels before firms would need to initiate cuts.

With that said, the analyst suggested that mobile DRAM will pick up on Apple Inc. AAPL's 2G DRAM in next gen phones, Microsoft Corporation MSFT's launch of Windows 10 and Intel corporation INTC's Skylake ramp and stabilize pricing in the bottom half of 2015.

Related Link: Brean: Apple Has 'Material' EPS Upside This Quarter

Has Foundry Capital Intensity Peaked At 16nm?

Malik cited QUALCOMM, Inc. QCOM driven 20nm demand weakness which is allowing Taiwan Semiconductor Mfg. Co. Ltd. TSM to increase equipment re-use to 90-95 percent from 80-85 percent historically resulting in flat capex spend per unit capacity in 2015.

Malik also added that Citigroup's foundry analyst Roland Shu expects foundry capex/10k wsm to rise $2 billion at 10nm driven by approximately 50 percent smaller cell size and more complicated "spacer" versus conventional LELE double patterning technology at 16nm.

Are Valuations Attractive?

Finally, Malik argued that Equipment stocks are trading at a 25 percent discount to semis on calendar 2016 P/E basis versus a five-year average discount of 18 percent. The analyst also added that increasing and less volatile technology or upgrade WFE spending mix on new devices and higher free cash flow return to investors should close the gap over time.

Malik singled out Applied Materials, Inc. AMAT as an attractive investment given its outsized silicon and services growth and higher capital returns. In addition, Lam Research Corporation LRCX offers investors the best pure play on deposition/etch secular growth.