Technology

Why Merrill Lynch Says Income Fund Managers Should Buy Semiconductor Stocks

Lee Jackson

Published: April 21, 2020 6:50 am

We have seen dividend yields skyrocket across all sectors as falling stock prices have pushed them higher. With bond yields tumbling to generational lows as investors looking for safety pile in, portfolio managers at income funds are finding themselves in a quandary looking for suitable investments. The problem portfolio managers have is that, in many sectors, dividends are being cut or eliminated altogether, and adding them to a portfolio looking to produce consistent income becomes a risky proposition.

In a new research report from Merrill Lynch, the firm’s semiconductor analyst Vivek Arya makes the case that income fund managers should probably be looking at the semiconductors for solid yield potential, and with good reason. Arya points out that the stocks are very underweighted, have resilient computing end-markets, trade at low 12 or 13 price-to-earnings ratios and, with other sectors facing severe cuts and reductions, the consistent and reliable dividends paid by the chip companies make sense in our brave new world.

We found four stocks that are rated Buy at Merrill and come with big dividends that make sense for portfolio managers and more aggressive retail investors.

Broadcom

This company has rallied smartly off the lows but still offers big upside potential. Broadcom Inc. (NASDAQ: AVGO) has an extensive semiconductor product portfolio that addresses applications within the wired infrastructure, wireless communications, enterprise storage and industrial end markets.

Applications for Broadcom’s products in its end markets include data center networking, home connectivity, broadband access, telecommunications equipment, smartphones and base stations, data center servers and storage, factory automation, power generation and alternative energy systems and displays.

Top Wall Street analysts like Broadcom’s leadership in the mobile, data center and broadband markets, and especially in the radio frequency (RF) arena. Many on Wall Street see a cyclical rebound in industrial and communications demand on the horizon.

Investors receive a very large 5.03% dividend. The Merrill price target for the shares is $305, and the Wall Street consensus target is lower at $296.04. Broadcom stock closed trading on Monday at $258.28 apiece.

Intel

This legacy leader in semiconductors has continued working hard to focus more on Internet of Things and data center cloud spending, and it was one of the top picks at Merrill Lynch for 2020. Intel Corp. (NASDAQ: INTC) designs, manufactures and sells integrated digital technology platforms worldwide.

The company’s platforms are used in various computing applications, comprising notebooks, two-in-one systems, desktops, servers, tablets, smartphones, wireless and wired connectivity products, wearables, retail devices and manufacturing devices, as well as for retail, transportation, industrial, buildings, home use and other market segments.

The analysts said this in front of the earnings for the first quarter, which will be reported this week:

We see inline first quarter, with our second quarter fiscal year 2020 estimated sales 3-4% below Street estimates. Focus on 10 nanometer manufacturing progress & on original $5 fiscal year 2020 earnings guidance (we/street now lower at $4.57/$4.82) We like Intel’s underappreciated scale/incumbency in secular AI/5G/cloud markets; the dividend yield also attractive/defensible.

Investors receive a 2.19% dividend. The Merrill analysts have set a price target of $68. The posted consensus price objective is $63.10, and the last Intel stock trade on Monday came in at $59.18.

This is a company the Merrill analysts favor as they see it as a smartphone content and infrastructure provider as well. Skyworks Solutions Inc. (NASDAQ: SWKS) designs, develops, manufactures and markets proprietary semiconductor products, including intellectual property worldwide.

The company’s product portfolio includes amplifiers, antenna tuners, attenuators, circulators/isolators, DC/DC converters, demodulators, detectors, diodes, directional couplers, diversity receive modules, filters, front-end modules, hybrids, LED drivers, low noise amplifiers, mixers, modulators, optocouplers/optoisolators, phase-locked loops, phase shifters, power dividers/combiners, receivers, switches, synthesizers, technical ceramics, voltage-controlled oscillators/synthesizers and voltage regulators, as well as wireless radio integrated circuits.

Skyworks provides its products for use in the aerospace, automotive, broadband, cellular infrastructure, connected home, industrial, medical, military, smartphone, tablet and wearable markets. It sells its products through direct sales force, electronic component distributors and independent sales representatives. The company has also benefited from an increased exposure to Apple products, and most on Wall Street see the potential for further margin expansion.

Shareholders receive a 1.90% dividend. The $110 Merrill price target compares with a $112.33 consensus target and the most recent closing share price of $92.53.

Texas Instruments

This old-school chip tech company offers solid value at current levels and is a great pick for investors who are more conservative. 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 business from those sectors, especially automotive, could suffer in the near term, the analyst feels the solid dividend should support the shares.

The company is also a big Apple supplier, so the long-term outlook for this venerable leader makes it a safer bet for accounts with less risk tolerance.

Investors receive a solid 3.23% dividend. Merrill has a $120 price target for the shares. The consensus target was last seen at $121.50. Texas Instruments stock closed at $111.53 a share on Monday.

The thought of income fund managers turning to chip stocks seems counterintuitive, but in today’s new normal, it makes perfect sense. Investors should tread carefully as first-quarter earnings for these are right around the corner, with some coming this week, smaller starting positions may be in order now.