Sending Out a Semi SOS: Chip Stocks Up the Creek Without a Paddle

by: William Trent, CFA

We have been concerned by the fact that semiconductor equipment orders are rising at a much faster rate than sale of semiconductors. Our reasoning is that the equipment will be used to make more semis, despite the fact that there are already signs of a glut. This, in turn, will lead to massive inventories and decimate pricing.

Well, it turns out that the picture is even worse than we were figuring. We were using data from the US-based Semiconductor Equipment and Materials International [SEMI] that reported orders for equipment rising more than 60 percent year/year. (The growth in semi demand is less than 10 percent.) Now the Semiconductor Equipment Association of Japan [SEAJ] has compiled its global data (in conjunction with SEMI) that shows that orders actually rose more than 70 percent.

Higher orders may sound like a good thing, but as we pointed out yesterday, the end result is ugly.

Reuters reports that:

Global sales of chip-making equipment in May posted the highest percentage growth in 17 months and demand is expected to stay firm in the coming months, an industry group said on Thursday.

Worldwide sales of tools used to make microchips came to $2.4 billion in May, up 20.2 percent from a year earlier, the Semiconductor Equipment Association of Japan [SEAJ] said.

Consumers’ robust appetite for mobile phones, personal computers and flat televisions is driving up demand for microchips that go into those products, prompting chip makers to boost production capacity.

The SEAJ compiles the monthly data with another industry group, California-based Semiconductor Equipment and Materials International [SEMI].

An SEAJ spokesman said global orders in May rose more than 70 percent from a year earlier.


There are many in the investment industry who believe that one needs close ties to industry participants in order to get the feel for how the market is moving before the crowd figures it out. We commented recently on Merrill Lynch’s semiconductor analyst lament that “There are too many investors taking too many airplanes to Taiwan and China, and the exercise is now undifferentiated and valueless.”

We actually have a somewhat different point of view, which is that those in the industry are often too close to the data to understand the big picture. We also have a corrolary that even if they do see the big picture they are likely to lie about gloss over it if it is negative. For example, a month ago we wrote that foundry UMC’s (NYSE:UMC) chairman and CEO expected capacity utilization to increase despite what we viewed as evidence to the contrary.

How quickly things change. As DigiTimes reports, foundry utilization may drop in 4Q:

Foundry utilization rates may drop from the fourth quarter of this year through the first quarter of next year amid an inventory pileup at customers, according to foundry sources.

Although both Intel (NASDAQ:INTC) and AMD (NYSE:AMD) are offering aggressive price cuts, the sources said that the time it takes to clear out PC-use chip inventory will be longer than expected, which is causing the foundries to become more conservative towards demand in the third quarter.

Furthermore, the wireless slowdown we highlighted recently will take some time to work through the system, but appears to have solidly formed. DigiTimes reports:

BenQ’s consolidated revenues in the second quarter fell 4.7% to NT$55.2 billion (US$1.7 billion) amid delayed shipments of some of its new handsets, according to today’s Chinese-language Economic Daily News [EDN].

At least some in the industry recognize the situation. Unlike some analysts, the folks at industry organization Semiconductor Equipment and Materials International [SEMI] are predicting flat equipment sales in 2007. That would help soak up the excess capacity being built this year. As Digitimes reports:

Following an anticipated decline of 11.3% in 2005, the equipment market will grow 18% to US$38.8 billion in 2006 but survey respondents see the market remaining flat in 2007 but expect double-digit growth over the following year to reach US$44.1 billion in 2008.

Semi 1-yr comparison chart:

Semi 1-yr comparison chart