Bank of America/Merrill Lynch (BAC) chip analyst Sumit Dhanda this morning turned cautious on semiconductor stocks, downgrading a slew of stocks; his colleague Daniel Heyler made a comparable on the foundries, lower ratings on a number of stocks.

“We are downgrading our view on the sector given unfavorable indications from our cyclical framework,” he writes. “In particular, our industry model suggests that following a period of rapid replenishment of inventory and normalization of semi shipments to true consumption levels, inventories in the supply chain are approaching a level suggesting a modest overshoot versus equilibrium levels. While we see limited risk to near-term estimates, we think the longer this persists the great the risk of a correction in the supply chain. Barring a sharp upturn in the global economies, this, in our view, renders the risk reward associated with ownership of chip stocks unattractive.”

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Bank of America’s Sumit Dhanda this morning upped his rating on Advanced Micro Devices (AMD) to Neutral from Sell, setting a price target of $6. “Having been consistently cautious on the stock since early 2006, we now believe that our thesis has largely played out–share losses to Intel (INTC), persistent pressure on cash flow/profitability, strain on the balance sheet–and that the stock has limited downside risk from current levels.”

He says longer-term headwinds remain, but that there are potential catalysts in the short-to-intermediate term, including improved free cash flow generation with the potential to reach break-even by Q4, reduced stress on the balance sheet as it finally shifts to an asset-lite strategy, and improved product uptake.

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