Semi Equipment Orders Continue To Rise

Semiconductor stocks, as reflected by the Semiconductor HOLDRS ETF (SMH), were down nearly 4% yesterday following disappointing news from equipment maker LAM Research (LRCX). As we noted prior to yesterday's open, LAM’s miss was due to customers finally realizing they were putting in too much capacity and responding by pushing back remaining orders. As LAM management noted during the company's conference call:

We’ve got a logic customer, who has fundamentally rethought their plans that had expected to take delivery in March and has now pushed that actually into the September and December quarters. And then the foundries, which have been positioning three or four months ago, about winding March deliveries have decided that they want to push most of those deliveries into June, a couple of the foundries have split their deliveries into the June quarter and the September quarters.

We have been anticipating such a turn of events for several months, and while we think shares remain overvalued we are hopeful the realization that the semi cycle is turning down will provide an attractive entry point. The problem is, just when we think semiconductor manufacturers have woken up and smelled the coffee they find some way to prove they are as dense as ever. According to the latest press release from Semiconductor Equipment and Materials International [SEMI]:

North American-based manufacturers of semiconductor equipment posted $1.52 billion in orders in December 2006 (three-month average basis) and a book-to-bill ratio of 1.05 according to the December 2006 Book-to-Bill Report published today by SEMI. A book-to-bill of 1.05 means that $105 worth of orders were received for every $100 of product billed for the month.

The three-month average of worldwide bookings in December 2006 was $1.52 billion. The bookings figure is about seven percent higher than the final November 2006 level of $1.43 billion and 33 percent above the $1.14 billion in orders posted in December 2005.

We won’t know what the December year/year growth in end-market semiconductor sales was until early February when the Semiconductor Industry Association [SIA] releases their own report. But we do know that it will be significantly less than 33%, because throughout 2006 it has ranged from 6.9% to 11.7%. What this means is that semiconductor manufacturers are still ordering more equipment than will be needed to make the chips customers are buying. And excess capacity, in turn, will mean continued inventory gluts, price cuts and profitability reductions.