Semiconductor Maker Quiet After Analyst Downgrading
Corporate Focus
by Anthony Palazzo
Even in a more restrained environment, it’s still rare to see a Wall Street analyst advise investors to sell a stock so rare, in fact, that the stray “sell” rating can cause the target company’s shares to wither.
International Rectifier Corp., the El Segundo-based maker of semiconductors for power-supply purposes, is a case in point. On June 20, Bank of America Securities analyst Douglas Lee downgraded International Rectifier to “underperform,” a version of “sell.” On that day and the following day, when the downgrade was disseminated to a broader audience, International Rectifier’s stock fell 34 percent, or $14.35 a share. The stock recently traded at $25.22, compared with prices in the mid-$40s during May and most of June.
Lee’s concern was that International Rectifier’s earnings projections of $1.61 per share for the year that ends in June 2003 were too high. He said his own, lower estimate of $1.35 could even be at risk given the uncertain recovery in key markets for International Rectifier.
The company’s response to the downgrade added to the uncertainty. In a statement, International Rectifier ignored the crucial question of whether its previous guidance would hold up over the next 12 months; instead, it reiterated numbers for the just-ended fourth quarter.
Now, analysts are split on International Rectifier’s prospects. The company is silent, and will remain so until it releases its fourth quarter earnings during the week of July 22.
“I think that their previous guidance for 2003 may be a bit aggressive,” said Todd Cooper, an analyst with Stephens Inc. who rates the stock “outperform.” But he added, “I do get a sense that their business is improving.”
Effect of PC sales
A key question is how well the PC market performs over the next year. The company makes integrated circuits and modules that are used to power the microprocessors that run personal computers and laptops. These products accounted for 28 percent of sales in the March quarter.
Two forces are in play: PC sales are weak, and analysts aren’t expecting a significant rebound anytime soon. But the industry also is making the transition to systems running Pentium IV chips, which require more power-management modules than Pentium III. So International Rectifier’s sales per machine will likely grow, it’s just a question of how quickly the new machines are adopted and how well prices hold up which in turn depend partly on the general economic climate.
As Lee points out, International Rectifier’s inventory ratios have been rising, its gross margins falling, and its cash-generation much weaker than its reported earnings. While sales into automotive, consumer and military markets aren’t in danger, the company generates roughly 40 percent of sales from information technology, “where demand signals have been weak,” Lee said.
Judging from broader numbers, more technology companies are in for a taste of what International Rectifier is going through. Overly optimistic projections are being rethought for the second half of 2002 and for 2003, although estimates must be lowered further before they hit reality, according to Chuck Hill, director of research at Thomson Financial First Call.
For the current third quarter, the overall tech sector is expected to show an earnings increase of 110 percent from the third quarter of 2001, Hill said. That’s down from 132 percent in late June and the larger estimate revisions don’t usually come until the quarter is well under way. The expected 52 percent increase that’s pegged for all of 2003 also is in danger, Hill said.
The bigger problem, Hill said, is that the ratios of buy-to-sell recommendations haven’t come down in a meaningful way. Despite the Merrill Lynch settlement in New York, and new regulations from the National Association of Securities Dealers, not much has changed there or at other brokerage firms, where sell ratings still account for less than 3 percent of all recommendations.
The only exception is at Morgan Stanley. “They’ve been out in front on this but outside of that there hasn’t been much change,” Lee said. He thinks others will follow, but “so far there hasn’t been any rush to get more realistic recommendations. Most still have an optimistic bias.”
Downgrades
A number of large media companies were rocked last week with downgrades from Kaufman Bros. media analyst Paul J. Kim. Citing a “post-bubble” environment that will limit revenue growth and render the conglomerates’ integrated structures a liability instead of a strategic advantage, Kim cut Burbank-based Walt Disney Co. to hold from buy, and Viacom Inc. to sell from hold. He also cut price targets on AOL-Time Warner (buy), while maintaining a buy rating on News Corp. All fell in the range of 4 to 5 percent on the day of the report, July 8, with the exception of News Corp., which fell 1 percent.
Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at
[email protected].
