Chip stocks 'have gotten ahead of themselves,' Citi says — but this 'top pick' can thrive

By Emily Bary

Micron dubbed Citi's new 'top pick' in the semiconductor space, while many other sector plays seem 'due for a pullback'

Chip stocks have enjoyed a recent run-up amid the frenzy over artificial intelligence, but Citi Research analyst Christopher Danely warned that semiconductor names "have gotten ahead of themselves" and seem "due for a pullback."

Despite market optimism about the sector's ability to capitalize on AI-related demand, "it appears only Nvidia (NVDA) is directly benefiting from generative AI as IT budgets, especially from cloud service providers, remain flat to down," Danely wrote. "We believe generative AI spending could be cannibalizing CPU [central processing unit] spending as budgets are not going up in a weaker macroenvironment."

Danely noted that the PHLX Semiconductor Index now trades with a 40% valuation premium relative to the S&P 500 . On an absolute basis, it was trading at 26 times earnings estimates for the next 12 months -- "all-time high" levels. That was even with the potential for many names to cut estimates during the next earnings season, in his view.

"We reiterate our cautious stance on the group given the melt-up driven by AI hype," he wrote.

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He named a new "top pick" in his latest note to clients, giving the nod to Micron Technology Inc. (MU), a stock that's missed most of the recent sector surge, rising only 1.5% over the past two weeks, as the PHLX Semiconductor Index has advanced 9.2%.

Danely expects Micron to benefit from an upturn in the market for DRAM (dynamic random-access memory) starting in the third quarter, and he sees a silver lining in the Chinese government's decision last month to ban critical information infrastructure operators in the country from using Micron products.

"We believe the China ban on Micron should put the company in position to get more money from the CHIPS Act, given that most companies appear to be opting for the minimum $150.0 million given costly contingencies," Danely wrote.

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He also upped his price target on shares of Advanced Micro Devices Inc. (AMD) to $120 from $85 in his Monday note to clients, though he kept a neutral rating on the stock.

"AMD appears to have a large design win for its MI300 chip; however we question the sustainability of a combined graphics/CPU IC given performance limitations and an unsuccessful history," he wrote. "While we expect AMD to keep gaining share, the ramp of its new Genoa product appears to be slower than expected."

-Emily Bary

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06-05-23 0818ET

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