Merrill Lynch Bullish on 4 Large-Cap Semiconductor Stocks in Front of Q3 Earnings

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If any subsector in technology is cyclical, it is the semiconductors. Toss in a massive trade dispute that has really muddied the waters for the chip stocks over the past year, and many investors have decided that the risks are just too great. The reality is that despite the numerous daunting issues the semiconductors have encountered, the Philadelphia Semiconductor Index (SOX) has traded in a bounded range for over six months and looks to be breaking out of a quadruple top pattern.

While the technical data may give some investors more comfort, the bottom line is that while earnings could be solid for the third quarter, fourth-quarter guidance could be sluggish, and that could take its toll on the sector.

In a set of new research reports, the Merrill Lynch analysts make the case that semiconductor stocks could move higher on solid earnings, seasonal strength and hopes for a 2020 recovery. They also point out that from 2010 to 2018, the fourth-quarter and first-quarter returns for the SOX index returned 19% versus 2% for the S&P 500.

The analysts have four large cap companies selected as top picks, and all make sense for aggressive growth accounts looking to add alpha over the next six months and beyond.

Analog Devices

This stock could very well continue to benefit from an increase in information technology and upcoming 5G spending. Analog Devices Inc. (NASDAQ: ADI) is a leader in the design, manufacture and marketing of analog, mixed-signal and digital signal-processing integrated circuits for use in industrial, automotive, consumer and communication markets worldwide. It offers signal-processing products that convert, condition and process real-world phenomena, such as temperature, pressure, sound, light, speed and motion, into electrical signals.

The company has among the best end-market exposure, with high communications and aerospace/defense market exposure, in addition to offering investors a powerful 5G content growth story. Plus, acquisitions over the past few years like Linear Technology and Hittite Microwave should provide revenue and additional cost synergies that are still coming.

Investors receive a 1.95% dividend. The Merrill Lynch price target for the stock is $130, and the Wall Street consensus target is $117.77. The stock closed Wednesday trading at $110.59 per share.

Nvidia

This sector leader made a huge purchase in the spring. Nvidia Corp. (NASDAQ: NVDA), a company that rarely has grown through acquisitions, bought Mellanox and paid a whopping $6.9 billion in cash. The deal has come under some scrutiny lately as some feel that the trade war and other issues could sidetrack the transaction, but for now it is still on.

Mellanox’s BlueField intelligent network adapters are another version of data center co-processing acceleration. Top Wall Street analysts see the combination of Nvidia and Mellanox as a definite threat to Intel’s data center CPU dominance of workloads. This indirect competition could ultimately be a problem for Intel shareholders.

Merrill Lynch feels that the third quarter could provide a solid print but note that fourth-quarter guidance, weak global growth and trade issues are still an overhang for the company.

Investors receive a 0.33% dividend. The $250 Merrill Lynch price target compares with the $193.10 consensus target. Shares closed Wednesday at $194.21.

NXP Semiconductors

This is still considered a top play for investors looking for a chip stock with Internet of Things (IoT) exposure, and it is a member of the Merrill Lynch US 1 list. NXP Semiconductors N.V. (NASDAQ: NXPI) became the fourth largest semiconductor company in the industry after it merged with Freescale in late 2015. It is also important to note that the combined company is the number one supplier in auto semiconductors with a 14% share, as well as the number one supplier in global microcontrollers and a dominant supplier in mobile payments.

NXP continues getting its chips into high-growth areas such as contactless mobile payments, the Internet of Things, mobile phone charging, increased cellular data consumption and even LED lighting. With shares trading at a solid discount to peers, some Wall Street analysts are very positive on the faster earnings growth potential relative to its competition.

Merrill Lynch has a $125 price target, while the consensus target is $117.77. Shares closed Wednesday at $108.61.

Texas Instruments

This classic old-school chip tech company offers solid value at current levels and is a great pick for more conservative investors. Texas Instruments Inc. (NASDAQ: TXN) is a broad-based supplier of semiconductor components, ranging from digital signal processors to high-performance analog components, to digital light-processing technology and calculators.

Some 65% of the company’s sales are exposed to the well-diversified, business-to-business industrial, automotive, communications infrastructure and enterprise markets. While the stock was hit hard recently as it is a big Apple supplier, the long-term outlook for this venerable leader makes it a safer bet for accounts with less risk tolerance.

In addition, the shift toward a parallel processing and IoT computing paradigm translates to secular demand growth for the company’s integrated circuits sold into IoT devices, which will ship in the tens of billions of units. Continued consolidation of analog industry translates to better pricing and higher gross margins, and the firm’s superior cost structure should translate to higher gross margins and share gains.

Investors receive a 2.78% dividend. Merrill Lynch has set a $150 price target. The consensus target is $129.37, and shares closed at $129.50.

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These four large-cap stocks have the potential to post solid third-quarter results. While fourth-quarter guidance could rock the boat some, it is important to remember the seasonal outperformance of the sector over the past decade.