My latest column is up at RealMoney.

In a normal economy, shares of Au Optronics (AUO) would be rising as fast as the company’s sales. Instead, sales and cash flow are zooming, and the company has been topping estimates by a wide margin, but shares keep moving sideways and now trade for less than 5 times projected EPS. In time, look for shares to catch up with the growth metrics.

AU Optronics makes thin film transistor liquid crystal display (TFT-LCD) panels and other flat-panel displays, which are used in notebook computers and desktop monitors, as well as in portable consumer electronics devices and LCD televisions. AUO competes primarily with LG Display (LPL) and Samsung Electronics, both of which are larger than AU. Corning (GLW - Annual Report) is also a significant force and is one of the company’s primary suppliers for glass substrates.

The company generated $4.8 billion in cash flow from operating activities in 2007 and used just $2 billion for capital expenditures. The resulting $2.8 billion in free cash flow represents a 17.7% free cash flow yield based on the current $15.84 billion enterprise value. Even if the free cash is cut in half (capital expenditures are expected to be twice as high this year) the yield would be more than double the current yield on five-year Treasury bills. That’s a pretty healthy premium for a company expected to grow 30% annually over the next three to five years.

Finally, AU Optronics is also trading at a mere 1.32 times book value, below the industry average of 1.62 times. Even if the company only grows in line with its 14% return on equity, an expansion to the industry average valuation could provide 20% annual total returns over the next five years.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

My latest RealMoney column is up, on Omnivision (OVTI). You can get the full story at their site, but in summary:

OmniVision derives 70%-80% of sales are derived from the camera cell phone market. Recent trends in the handset market suggest there could be some bumps in the road ahead. Handsets have been selling like hotcakes, but recent cooling signs have emerged.

In a tougher handset market, I’d also expect a tougher pricing environment for OmniVision and its peers. Competitors in the market for CMOS image sensors include MagnaChip, Micron (MU - Annual Report) , Samsung, Sony (SNE - Annual Report) , ST Microelectronics (STM) and Toshiba. The company also faces competition from the makers of CCD chips, which have typically represented the higher-end products.

Still, I like the recent trend in OmniVision and the potential for expanded interest among value investors in coming months. With appropriate protection (such as tight trading stops), it might be worth taking a risk in the name.

Alternatively, the April $17.50 puts are $0.80 as I write this. Writing the puts would offer either a 4.5% five-week yield on the money risked, or a more attractive entry point of $16.70 should the options be exercised.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned.

Trade group Semiconductor Equipment and Materials International (SEMI) is expecting stong equipment orders from memory makers this year, according to DigiTimes.

Investment on 12-inch fabs and memory production will be the two main growth drivers for fab spending in in 2007, and 85% of all fab spending will go toward equipping 12-inch fabs in 2007 according to SEMI.A total of about 23 million 8-inch equivalent wafers of new capacity is added in 2007, which represents an on-year growth about 16%, SEMI estimated. Samsung Electronics is the stand-out leading in terms of capacity, followed by Hynix Semiconductor, Taiwan Semiconductor Manufacturing Company (TSMC), Toshiba, Intel and Micron Technology, SEMI detailed.

Yet channel checks by Citigroup have suggested just the opposite, says Barron’s.

Samsung has pushed out some order for semiconductor back-end tool orders, according to Citigroup’s Timothy Arcuri. He says orders are being pushed out by about three months, and is likely to extend to front-end tools. “While we don’t know exact reasons for the pushout, we surmise ongoing memory price declines are too blame,” he writes.

As far as the likely order pattern, I’m with Citigroup on this one, as I was warning about pending overcapacity issues for the better part of the last year. The chart of memory prices is not the sort of pattern that inspires new investment. Now that it is happening, however, I’m looking for opportunities to buy on the news.

Disclosure: William Trent has a long position in SMH.

Lest you think we were going soft, we hereby balance our earlier enthusiasm for semi stocks with our more customary caution. The five reasons to avoid semiconductor stocks right now include:

1. The fundamentals will get worse before they get better. While supply indications grew slower than demand in April, the turn followed 16 months of too much capacity being ordered. As that capacity comes on line, the inventory situation will worsen and margins will get hit more. It is not at all certain that estimates reflect this.
2. It is May. Sure, sell in May and go away is a cliche. Things often become cliches for a reason.
3. Demand? What demand?
4. Valuations are too high because investors are hoping for more premium buyouts. They will happen, but not to every name in the sector.
5. The last bear may no longer be standing.

Food for thought.

Disclosure: William Trent has a long position in SMH.

A reader complained yesterday that we have been too negative. While we aren’t going to go crazy and have a whole positivity day, we will take the time to outline the bull case for the industry on which we have been most negative: semiconductors.

1. The bad news is known. When we started harping about oversupply, it was the farthest thing from anyone’s mind. Like Heisenberg’s uncertainty principle, the act of observation can alter the experiment.
2. The market is ignoring the fundamentals. Related to point 1, the market knows about the bad fundamentals and doesn’t care. Often this means that the bad news is sufficiently well known to be priced in. This is of course the weakest reason, as the market ignored the fundamentals in 2000 as well.
3. Demand may be ready to pick up. Double-digit growth from a tech distributor for the first time in a long time should not be ignored. The Vista hoopla has passed, now the nuts and bolts work may be beginning.
4. Supply and demand will soon realign. For the first time since 2005, orders for new equipment grew at a slower rate than semiconductor end demand. The longer this situation continues, the healthier it will be for future industry sales, pricing and profit margins.
5. The game has changed. Forget private equity buyers. For the first time a semiconductor management team decided it was more important to take capital out of the industry than to add more. This is a sea change in semiconductor management-think, and the strong positive reaction from investors ensures that the wave will continue to build.

There. That wasn’t so hard, was it? Stay tuned for our five reasons NOT to buy semiconductor stocks today.

Disclosure: William Trent has a long position in SMH.

We have been talking about oversupply of semiconductors for some time. Now, in the last two weeks two research firms have cut forecasts according to Semiconductor Fabtech:

IC Insights has drastically cut its semiconductor growth projections for 2007 citing severe pricing pressures in the NAND flash memory market as well as the continued decline in microprocessor prices. However, the market research firm has added that a major DRAM price collapse has also started and will also affect market growth this year. As a result, the firm has lowered its forecast to 2 percent growth compared to its previous forecast of 7 percent growth for 2007.Only two weeks ago, Semico Research lowered its semiconductor forecast for the second time this year citing poor prices even though unit demand remained strong, and now projects only 1.8 percent growth for 2007. In March, Semico had projected growth of 5.8 percent compared to a projection at the beginning of the year that the semiconductor industry would grow by 7 percent.

While everyone plays catchup we will refer you back to our October 2006 comments, which have not needed any revisions:

The chart below shows the year/year growth rate in semiconductor sales for each month going back to 1998. Data is courtesy of the Semiconductor Industry Association (SIA).

This tells us a few things:

• The semiconductor sales growth rate has been more consistent since 2005 (in the mid-high single digits.)
• The forecast calls for that to essentially continue for two more years.
• The chart tells us that is pretty dadgum unlikely.

Sales growth is likely to be either much higher or much lower than 8.6% next year. The million dollar question (or however much you may have at stake - for us it’s more like a couple thousand) is which direction. We’re betting it is lower.

For one thing, this is the longest the semi industry has ever gone without a year/year decline. By itself that doesn’t mean much - due to the fabless/foundry model and general tech industry maturity sales growth should be less volatile.

However, when you combine low volatility in sales growth with huge orders for new manufacturing equipment you end up with oversupply. Oversupply in a cyclical industry means sharper than normal price reductions. If the prices fall faster than unit demand rises - you get a decline in sales.

The other reason we expect semiconductor sales to be less than the industry predicts next year is summed up in the following chart, which tracks the total sales (rather than growth) over the preceding twelve months. There has been a definite change in the overall growth rate, going back to about 1995 or 1996, depending on where you want to draw the lines. For simplicity, we’ll just use the last 10 years (September 1996 - August 2006). Over that time frame, the average growth rate has been 6.3%. However, it is easy to see that that rate is toward the top of the new range (the trendline represents resistance in this case.)

So, given overcapacity, volatility and resistance we think 8.6% growth in 2007 is on the optimistic side. Perhaps even the wildly optimistic side.

We’ll have to wait and see how much of a shakeup there is in 2007 before we’d be willing to comment on 2008.

Disclosure: William Trent has a long position in SMH.

When Semiconductor Equipment and Materials International (SEMI), the industry trade organization for semiconductor equipment makers, reported the January book to bill ratio for chip equipment, we were concerned.

Unfortunately, just when it looked as if things might be set to turn the semiconductor companies re-accelerated their pace of equipment orders over the last two months.

Until orders for semiconductor equipment start growing at less than the roughly 10% growth in demand for semis, there will continue to be the brutal pricing environment we have seen recently. The decent guidance and calling of bottoms are pipe dreams.

But now it appears there could be another reason for the datapoint we found so strange. According to Reuters.com:

Global sales of microchip-making equipment in February rose 16.6 percent from a year earlier on demand for tools to make and process silicon wafers, an industry group in Japan said on Friday.Sales of gear used to make semiconductors rose to $2.72 billion in February, the Semiconductor Equipment Association of Japan (SEAJ) said.

The group also restated sales figures for January, saying sales rose 17.2 percent year-on-year to $3.49 billion, instead of a previously stated rise of 34.5 percent to $4.01 billion.

A member of Semiconductor Equipment and Materials International, a California-based industry group, had given the wrong sales numbers, the SEAJ said in a statement.

Then SEMI reported adjusted figures. Here is what the numbers looked like in February as originally reported:

And here is the new and improved data:

The March numbers will be reported Thursday. Given that the supply/demand imbalance is the main contributor to our bearishness, a continuation in this trend would mean we are much closer to adopting a neutral/bullish outlook for semis. We can’t wait for Thursday’s release to find out.

Disclosure: William Trent has a long position in SMH.

When we saw predictions of a second-half rebound for DRAM prices, we said:

Or, more likely, vendors hope demand will kick in later this year. Furthermore, with all the new supply being added it is unlikely to be absorbed even if demand does pick up. We don’t think prices will rebound in 2007, although the stocks may bottom this year ahead of the bottom in industry fundamentals.

But perhaps we were misinterpreting. Perhaps by “propping up” prices they meant that prices would fall more slowly. Alas, even that may be a premature hope, according to DRAMeXchange:

After experiencing a temporary rebound, the DRAM spot price has started to weaken again. Amid the national holidays in the Hong Kong and Taiwan markets, minimal transactions were seen. The DDR2 512Mb 667MHz chip price stayed near the USD 2.9 level, while the DDR2 eTT slipped to USD 2.65.

Oh, and we already covered the New Year Holiday myth so we won’t go there again.

According to iSupply, the top DRAM producers (exposed stocks) are:

1. Samsung (SSNLF.PK), 27.8 percent
2. Qimonda (QI), 16.9 percent
3. Hynix (HXSCF.PK), 15.8 percent
4. Micron (MU - Annual Report), 10.6 percent
5. Elpida (ELPDF.PK), 10.2 percent
6. Nanya, 6.6 percent
7. Powerchip, 4.8 percent
8. ProMos, 4.5 percent
9. Etron, 0.9 percent
10. Winbond (WBEMF.PK), 0.6 percent

Caveat emptor.