Citi Remains Cautious On Semis Ahead Of Q1 Earnings

Christopher Danely of Citi remains cautious on the semiconductor sector and expects the sector to face headwinds for at least the first half of 2016. Citi's favorite stocks to buy now are Buy-rated Microchip Technology Inc. MCHP and ON Semiconductor Corp ON.

"We expect a reduction to Consensus estimates during 1Q16 earnings season as the PC and handset end markets (combined roughly 50% of semi revenue) remain weak," Danely wrote in a note.

The weak PC end market is bad for Intel Corporation INTC. Citi analyst Jim Suva forecasts PCs to decline 6 percent in 2016, below Intel's forecast of down low single digits.

"We remain cautious on Intel due to our belief in downside to Consensus estimates," the analyst added.

Meanwhile, Danely attributed the weak handset end market to weak Apple Inc. AAPL supply chain and though the strong shipments of initial Samsung S7 are positive for Maxim Integrated Products Inc. MXIM, the analyst is "unsure if Samsung cell phone momentum will last."

In addition, the analyst expects the automotive end market to be the strongest end market, which is good for ON Semi (33 percent of calendar 2015 sales), Microchip (25 percent), and Linear Technology Corporation LLTC (22 percent).

"We believe the industrial end market is improving while the comm end market is getting worse," Danely continued.

The analyst believes the movement of semi stocks in 2016 is going to be like 2012, when the SOX index rose about 20 percent in early 2012 but subsequently declined roughly 20 percent.

With the SOX index up roughly 23 percent trough-to-peak in 2016, Danely believes semi stocks could decline roughly 20 percent in the next few months.

Given the difficult demand environment, the analyst favors stocks that can benefit from M&A such as Microchip driven by accretion from Micrel and Atmel, and ON Semi driven by accretion from Fairchild. Citi's other Buy-rated stocks are Texas Instruments Incorporated TXN and Analog Devices, Inc. ADI.