The Chip Glut Is Beyond Semi-Serious

After yesterday’s Agere (AGR) preannouncement, we decided to update our research on semiconductor industry fundamentals. This has been made easier since we received a complimentary trial of Zacks Research Wizard.

We first note that days inventory on hand at 39 semiconductor companies listed on public markets in the U.S. improved slightly in the December quarter. This improvement is in line with normal seasonality, as the holiday season is typically marked by strong sales of consumer electronics and the inventory moves away from the manufacturer toward the end user. On a year/year basis to more accurately reflect the seasonality, the days inventory on hand rose.

What the chart doesn’t show is what happened to inventory in the channel. For the uninitiated, the “channel” is everything between manufacturer and end user. For semiconductors, the channel includes distributors, the manufacturers that put the chips into end products such as cell phones or computers, and distributors, wholesalers and retailers of the end products. Given the increasing evidence of slowing consumer demand, the channel inventory could be particularly significant right now (remember Agere’s warning was due to channel inventory corrections).

Next we turn to capacity utilization, which has clearly started to fall. Excess capacity means the potential for even more inventory to be produced, which tends to put downward pressure on prices. Since the majority of semiconductor manufacturing costs are fixed, low utilization means lower profits - either because prices have to be reduced or because the per-unit costs are higher when production is cut.

Next we turn to orders for new semiconductor equipment, which when installed will increase capacity still further (thus lowering utilization still further). The new equipment orders continue to rise at a much faster rate than the end demand for semiconductors.

So there you have it - on an industry-wide basis things are bad and appear likely to get worse. We’ll finish things off with a list of the companies whose days inventory grew year/year:

Author's note: Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Comments

[User 1:]

Mr. Trent, great analysis as always. But you have been bearish for so long on this sector, and it just hasn't materialized for stockholders. How do you explain that?

Also, how do you explain the ongoing bullishness from the sell-side -- like this from yesterday:

chip.seekingalpha.com/...

2007 Mar 27 01:22 PM

[William Trent1:]

Thanks.

I have been (publicly) bearish for approximately 1 year, and during that time the SOX is down about 5% vs. a 10% gain in the S&P 500, so I wouldn't say the bearish outlook was invalid. Admittedly (which I have also noted) I may have missed the August bottom. The data just haven't reversed enough to warrant a turn toward bullishness on my part.

To be specific, I think the fundamentals are going to get much worse, but the market will look past the bottom in fundamentals and the stocks will recover before the fundamentals do. I am not confident, yet, that we have reached that point but it is possible that we have. Sorry I can't be more helpful than that.

As far as the article you referenced, I share Notable Calls' opinion.

2007 Mar 27 01:34 PM

[stan:]

Mr Trent ... very thought proboking analysis. I can't help wondering how the major foreign semi manufacturers would affect your conclusions.

Japanese, Korean and Taiwinese manufacturers as well as some of the Eurpoean semi guys are major players in semiconductor supply.

China is now the world's #1 producer of semiconductors ... true, it's for their own internal market and so doesn't directly bear on world supply/demand dynamics ... and so may be ignored for this analysis.

I would be interested in your opinion of the effect of the foreign producers.

2007 Mar 28 10:54 AM

[William Trent1:]

Chips are a global commodity, and the foreign producers are having considerable impact. Some of the data presented above are U.S. specific, while others I follow (such as the SIA Global Sales Report) are global.

Other dynamics, such as inventory levels, are probably something that can be extrapolated. If US chipmakers are building inventory it could mean that foreign manufacturers are taking share, or it could mean that foreign manufacturers are also building inventory. In the short term the latter is usually more significant that the former but it is something to be aware of as the counter-argument.

I would say the weakest data above, with respect to a more global chip industry, is the capacity utilization figure. With more new fabs built overseas than in the U.S., U.S. capacity utilization is less relevant to the total industry than it has been historically. By using the Fed data, I am making an implicit assumption that global fabs are all being utilized at roughly the same rate. Sometimes this will not be the case.

2007 Mar 28 12:05 PM

[YenKenZen:]

Mr. Trent,

I quickly checked another piece of data. Though a bit North America centric, PCB book-to-bill ratio does provide leading indication of chip sector and this one sint looking good either!
www.ipc.org/ContentPag...

I wonder how bad does current chip b-b ratio looks like!

2007 Mar 29 08:53 PM

[William Trent1:]

It may be weakening now, but it must have been strong at some point for the semis to be adding so much capacity. The problem with that is that orders can be canceled. Somehow the chip industry always believes the orders are for real "this time" even though they have been proved wrong over and over.

Eternal optimists, I guess.

2007 Mar 29 10:08 PM

[YenKenZen:]

Hi William,

Here is a very different view

www.smartmoney.com/Tec...;pgnum=1

any comment?

2007 Apr 04 05:39 PM

[William Trent1:]

One word: Yes.

I still believe things will hit bottom when the orders for new supply start to grow slower than end demand.

2007 Apr 04 06:48 PM