Why Microchip, SanDisk Might Be The Way To Play A Semiconductor Rebound

The semiconductor space is one of the most hotly contested sectors between bulls on bears.

In a report published Monday, JPMorgan analyst Harlan Sur noted that while some bears are pricing in further downside in semiconductor stocks through the rest of the year, the supply-side dynamics are in "relatively good shape" based on inventory draw-down depletion in the value chain over the past three quarters.

According to Sur, the PHLX Semiconductor index may see near-term retests of its August low, but investors should start accumulating semiconductor stocks now. The analyst added that the last major round of consensus estimate cuts is expected to take place in the upcoming earnings season (following negative earnings revisions in the first and second quarters) while industry fundamentals is "likely" to improve in the first half of next year.

Related Link: Pacific Crest: How To Pick Semiconductor Winners

"With our expectations of 20-30 percent upside in semi stocks over the next 18 months, we believe the risk/reward profile is favorable for taking on new long positions and M&A/consolidation will likely continue (still early innings of industry consolidation) and help keep a bid in stocks," Sur wrote.

Upgrading Microchip To Overweight

Shares of Microchip Technology Inc. (NASDAQ: MCHP) were upgraded to Overweight from Neutral with a $54 price target based on Sur's expectations of improved fundamentals in the company's business as global channel inventories should get "worked down" over the next two quarters following three quarters of under-shipping consumption.

Sur also noted that Microchip's product portfolio will continue to show above-market growth across all of its segments (8, 16, 32-bit) while its acquisition of Micrel is expected to drive "better than expected" synergies over the next one to two years.

Finally, the stock is trading at a "meaningful" discount relative to its peers while a 3.5 percent dividend yield protects the stock from further downside at current levels.

Upgrading SanDisk To Overweight

Sur also upgraded shares of SanDisk Corporation (NASDAQ: SNDK) to Overweight from Neutral with an unchanged $70 price target as the company has now passed its execution issues in the enterprise flash market and can now resume growth in the enterprise and client/embedded segments.

In fact, the analyst suggested that the enterprise SSD market is expected to grow at a 20 percent compounded annual growth rate over the next few years – implying the stock's multiple will expand in kind as well.

Sur also noted a "relatively favorable" fundamental environment for NAND into next year as the company will maintain its cost leadership when transitioning into 3D NAND.