Ahead of Intel Earnings, S&P Looks at Chip ETFs

Intel (NASDAQ:INTC), the world's largest semiconductor maker, is scheduled to deliver its latest quarterly results today after the close of U.S. markets. Ahead of that report, some chip ETFs are trading higher.

On the heels of some positive commentary on the sector from Goldman Sachs earlier this month, S&P Capital IQ raised its 12-month fundamental outlook on chip stocks to positive from neutral this week.

"After about a 3% sales decline estimated for 2012, the industry is poised to grow about 4% in 2013, in our view," said S&P Capital IQ in a research note. "We see the strength led by a pickup in communications spending, continued growth in consumer electronics, an uptick in automotive, and GDP-like growth in military and industrial end markets."

In 2012, the semiconductor sub-sector lagged the broader market as the Philadelphia Semiconductor Index returned just four percent compared to a gain of nearly 12 percent for the S&P 500. As S&P Capital IQ notes, that was the third straight year in which the Philadelphia Semiconductor Index trailed the S&P 500, but things could be better for the group this year.

"Turning to 2013, we believe the industry is in good shape to at least grow in line with global GDP, likely reversing much of the trends seen last year, such as some chip customers' lean inventories, low utilization, and cost-cutting," said S&P. "We think communications end market spending will bounce back in 2013. Wireless and wireline communications account for approximately 32% of chip sales, and we expect this end market to pick up on pent-up demand."

Despite the encouraging outlook on the semiconductor group for 2013, S&P Capital IQ currently has Underweight ratings on several marquee semiconductor ETFs, including the Market Vectors Semiconductor ETF (NYSE:SMH).

SMH is heavily allocated to just two stocks Intel and Taiwan Semiconductor (NYSE:TSM). Those names combine for almost 35 percent of the fund's weight and predictably act as the primary drivers of the ETF's returns. Despite an unimpressive 2012 performance, SMH showed signs of life late in the year and including today's performance, the ETF has gained almost 10 percent in the past three months.

Other top holdings in SMH include Texas Instruments (NASDAQ:TXN), Broadcom (NASDAQ:BRCM) and Applied Materials (NASDAQ:AMAT).

Another ETF S&P rates as Underweight is the iShares PHLX SOX Semiconductor Sector Index Fund (NASDAQ:SOXX). SOXX is also heavy on the likes of Intel, Texas Instruments, Broadcom, Applied Materials and Taiwan Semiconductor as those names combine for about 40 percent of the ETF's weight. Importantly, SOXX spreads its allocations around a bit more than SMH as no single stock represents more than 8.4 percent of SOXX's weight. SOXX has gained about eight percent in the past 90 days.

Due to tablets and other devices stealing market share from traditional personal computers, S&P warned computing semiconductor revenue could be flat this year.

Industry data suggests portable devices are cannibalizing the traditional PC market (computing), and indicates software investment will be at the expense of enterprise hardware. We believe these trends likely portend a long-term, structural shift; thus, we look for computing-based semiconductor revenue to be flat in 2013 after a near 8% decline seen for 2012," the research firm said in the note.

S&P Capital IQ also has Underweight ratings on the PowerShares Dynamic Semiconductors Portfolio (NYSE:PSI) and the SPDR S&P Semiconductor ETF (NYSE:XSD).

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