Morgan Stanley Cuts Two Semi Shares as It Adopts Mid-Upcycle View By

Morgan Stanley reported Wednesday that shipments of analog and microcontroller units (MCUs) in the semiconductor sector hit a low in the second quarter.

Historically, identifying this fundamental bottom has led to outperformance. This time, however, stocks hit an eight-month low as companies signaled a “final decline.” Analysts said similar names are now trading at a 50% premium to historical averages.

“We are moving to a mid-upcycle playbook and a selective approach, although a positive correlation between undershipping and 12-month returns keeps us positive on the cohort,” they wrote in a note.

Analysts believe the multiples are justified, but they do not expect any standout performances this cycle.

They are tackling two key debates: generating alpha in an upcycle, historically achieved through structural business improvements, or industry-beating revenue growth with stable margins. This time around, they see no candidates that meet those criteria, the Morgan Stanley team says.

They further consider the justification for multiple investments, noting that analogous investments trade at a 50% multiple premium to historical ratios, in line with the SOX ETF, which seems reasonable given the expansion and consolidation of margins over the cycle.

As multiples widen, analysts expect estimate revisions to boost returns. Historically, consensus estimates tend to understate both upside and downside cycles, leaving room for revisions.

They are now taking a more selective approach and downgrading Microchip Technology (NASDAQ:) to Equal Weight and ON Semiconductor (NASDAQ:) to Underweight.

“We believe MCHP’s valuation reflects high expectations, while a deeper decline with a heavy balance sheet will slow the pace of deleveraging,” analysts said.

“ON faces headwinds in revenue growth in automotive semiconductors, SiC and image sensors, which tempers our margin view. As a result, we see little room for multiple expansion,” they added.

Shares of MCHP and ON fell more than 2% and 3%, respectively, in pre-market trading.

Morgan Stanley remains Overweight on Analog devices (NASDAQ:), stating that its relatively higher ASP products should limit competition with emerging Chinese capacity, and that revenue prospects are good with a book-to-bill ratio of greater than 1 in all end markets.