Why Wells Fargo 2015 Semiconductor Outlook Is Optimistic but Cautious

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To kick off 2015, Wells Fargo released its outlook on the semiconductor industry. The analyst firm is very strong on the fundamentals for this new year, even considering the soft patch that came at the end of 2014. However, Wells Fargo remains cautious on chip stocks overall with a Market Weight sector rating.

Chip growth is expected to accelerate though 2015 and grow within the range of 8% to 12% for the full year. This is potentially two to three times the 2015 3% to 5% growth projections of various market research organizations, such as WSTS and Gartner, comparable to or slightly higher than the 9% to 10% growth of 2014. At the same time, it is better than the flat sales in 2011, a 3% decline in 2012 and 5% growth in 2013.

Despite the cautious Market Weight group rating, some selective investments within the group do get an Outperform rating. Wells Fargo’s top large-cap chip picks for 2015 are Intel Corp. (NASDAQ: INTC) and Qualcomm Inc. (NASDAQ: QCOM).

Intel remains the analyst firm’s top pick. Its strong positioning in high-margin server processors is expected to drive earnings per share growth over the next few years. Also the investment community may be underestimating the growth potential of the PC segment. A big factor in 2015 will be Intel’s ability to reduce losses in its mobile chip businesses, which will improve its margins and earnings per share in 2015 and 2016.

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Wells Fargo said about Intel:

We think that Intel’s leadership position in chip manufacturing technology is an important competitive advantage for the company’s processor products, and might also help Intel win key new foundry customers in the future.

Qualcomm is rated as Outperform and is on Wells Fargo’s Priority Stock List. The analyst firm believes that Qualcomm is not fully appreciated by investors for its leadership position in 4G communications chip technology. However, there are some legal and regulatory customer disputes at the moment to do carry some risk and uncertainty with the stock. Wells Fargo is optimistic that there will be a positive resolution to Qualcomm’s issues in China, and further believes that this could prove to be a positive catalyst to the stock and a source of potential earnings per share upside at various points over the next one to three years.

Altera Corp. (NASDAQ: ALTR), Linear Technology Corp. (NASDAQ: LLTC) and Xilinx Inc. (NASDAQ: XLNX) are broad-based mid-cap stocks that Wells Fargo rates Outperform. All three companies have solid profitability, in Wells Fargo’s view, and a broad base of customers and end markets. Linear has best-in-class profitability, with a history of gross margins in the 75% to 80% range and operating margins in the 45% to more than 50% range.

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Advanced Micro Devices (NASDAQ: AMD), Micrel Inc. (NASDAQ: MCRL) and SunEdison Inc. (NYSE: SUNE) are the small-cap stocks that are rated as Outperform. According to Wells Fargo, AMD and SunEdison both offer significant valuation upside potential. SunEdison is considered an interesting cyclical play in a recovering chip demand environment, in which Wells Fargo expects there to be the opportunity for pricing increases in blank wafers and high-margin leverage. AMD is in the middle of a turnaround, with a new CEO, which could provide high-margin leverage as well.