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Many semiconductor analysts have been eager to call a “bottom” to the present semiconductor cycle, with some calling a bottom as far back as September, pointing to order stabilization and healthier supply chain inventory. The semiconductor analyst team at Bluefin Research has been more cautious in our assessment of the industry, recognizing that unstable demand has been a far bigger factor than supply chain excess in the recent market downturn -- and a few weeks of demand stability doesn’t necessarily mean we’re at an inflection point.

For investors bullish on semiconductor stocks, the recent negative pre-announcements by Texas Instruments (NASDAQ:TXN) (TXN mid-quarter update), Altera (NASDAQ:ALTR) (ALTR mid-quarter update), and Lattice Semiconductor (NASDAQ:LSCC) (LSCC pre-announcement) should have been a wake-up call that perhaps a bottom is not so near. TXN and ALTR management claim they are under shipping end-demand, but have little data to back their claims up. A sobering survey of OEM procurement and sales personnel by VentureOutsource indicates that the outlook for the electronics supply chain is very pessimistic, with little improvement in sight in the next two quarters. The report also validates our industry checks that revealed deteriorating market conditions in China and Europe.

Don’t underestimate the degree of weakness in China as anemic domestic consumption adding to export woes. Our recent trip to China underscored the many challenges that Chinese technology companies face in dealing with the slowing economy in China. Thousands of factories have closed this year, crippled by weakening exports and spiraling production costs. Factory wages have increased by 35% this year in tech-centric Shenzhen, and the local government is awaiting approval from the Central Government on an additional 14% increase effective January 1st. Unfortunately, the factory workers are not feeling any richer, as food, transportation and housing costs have risen dramatically as well. Factory workers also depend on overtime wages, which typically added 30-40% to their total income, but production overtime is not needed in this weak export environment. Exports in Guandong province declined 9% on a sequential basis in the typically seasonally-strong October, with no turnaround in sight.

Industry contacts on the ground in China are growing more concerned about domestic consumption now as well. Housing prices and sales have steadily declined since September, and it is starting to impact aggregate demand for consumer electronics and home appliances, according to our checks. The China PMI dropped from 50.4% to 49.0% in November, indicating a contraction (below 50% indicates contraction) for the first time since February ’09. Many small technology companies have either gone out of business or sharply cut back production, unable to borrow money to meet their capital requirements. Some companies have resorted to securing loans via “shadow lending,” but the borrowing rates are exorbitant. We are hearing that even large communications OEMs such as Fiberhome and ZTE have asked suppliers for extended payment terms with interest charges in order to combat short term capital challenges.

The PBOC (China Central Bank) recently lowered the reserve requirement ratio to Chinese banks by 50 basis points. Industry contacts believe this will help alleviate some of the credit issues, but much of the damage is irreversible and it is questionable whether small businesses will benefit from the loosening credit policy. These economic challenges have dealt a body blow to the technology sector in China. Weak exports now coupled with anemic domestic consumption have resulted in disappointing demand for everything from cellular handsets, PCs and LCD TVs to home appliances and industrial goods. We think the upside in North America should help offset some of this weakness in the December quarter, but the outlook is looking less promising for a March quarter recovery for the semiconductor industry.

We believe most of the Wall Street estimates for the March quarter and 2012 overall are too high, and caution investors who believe all the bad news is already “out.” Below we offer ten reasons why the first quarter is likely to continue the string of sub-seasonal quarters in the semiconductor industry.

1. China. Tech-centric Guandong province exports dropped 9% sequentially in October in part due to weak consumer electronics and PC sales to U.S. and Europe. China’s PMI index dropped 140 basis points to 49.0 in November, signaling a contraction in the manufacturing sector. Weak exports now coupled with anemic domestic consumption have resulted in disappointing demand for everything from cellular handsets, PCs and LCD TVs to home appliances and industrial goods.

2. Hard Disk Drive (HDD) Shortages. The floods in Thailand have reduced global HDD builds to approximately 120 million units in the fourth quarter according to industry leaders Western Digital (NASDAQ:WDC) and Seagate (NASDAQ:STX), roughly 50 million units below aggregate demand. This demand gap has been largely filled by roughly 6 weeks of supply chain inventory that existed prior to the floods. While HDD production is expected to increase modestly in the first quarter, the supply chain inventory will be depleted, leading to shortages throughout the supply chain. The shortages have been limited to the smaller white box PC suppliers this quarter, but we expect supply shortages to impact the larger OEMs in the first quarter as well. Early ODM forecasts are projecting notebook builds to be down 15% sequentially (Bluefin Research estimates) in the first quarter in part due to HDD shortages, well below typical 5-10% seasonal decline. The PC segment still represents over 30% of semiconductor revenues, so a 5-10% sub-seasonal PC production output would have a material impact on semiconductor industry revenues in the first quarter. HDD shortages are likely to be felt in the consumer (set top box, gaming) and industrial segments as well.

3. Wireless Communications. Sharp reductions in carrier capital spending in the back half of 2011 triggered a wave of pre-announcements from semiconductor suppliers with heavy weighting in the communications segment. AT&T (NYSE:T) and Verizon (NYSE:VZ) slowed their LTE deployment in North America, while European carriers cut back sharply on 3G deployment as the debt crisis intensified. In Asia, China Mobile has reduced investment in 3G and delayed their most recent TD-SCDMA tender, while India’s 3G deployment has been disappointing. Despite conventional wisdom that suggests the carriers cannot continue to hold off on network expansion as data bandwidth continues to explode, our early reads into the first quarter suggest that this trend is not likely to turn around just yet.

4. Home Appliances. The elimination of energy efficiency subsidies in North America and China have cooled down the demand for green energy appliances. Industry observers believe the removal of these subsidies, coupled with a weak housing market in the U.S. and China will have an adverse impact on the traditionally strong first quarter appliance sales. Our channel checks suggest that market demand has been weak in the fourth quarter and industry contacts don’t expect it to turn around in the first quarter.

5. Smartphones. In the present downturn, smartphones have been one of the few bright spots for semiconductor suppliers. The later than expected launch of the Apple (NASDAQ:AAPL) iPhone 4S led to tremendous pent up demand. However, the unprecedented level of “hero” phone launches in the last four months (iPhone 4S, Samsung Nexus and Galaxy S2 family, Motorola Droid, Blackberry 7 OS family) will likely leave a demand void after the holidays. As a result, we expect smartphone sales to perform below typical seasonality in the first quarter.

6. Europe Industrial. Up until now, the European industrial market has been surprisingly resilient despite the looming debt crisis, with demand weakness limited to the countries in the center of the crisis. However, recent industry checks indicate that even the German industrial market has softened in recent weeks. The Europe market tends to lag North America on both sides of the cycle, so we believe the European industrial segment will not show the signs of stabilization that we have recently witnessed in North America for at least another quarter.

7. Early Chinese New Year (CNY). Chinese New Year begins on January 23rd, a full eleven days earlier than last year. As a result, component pull-ins for pre-holiday builds will commence in December this year, taking some of the CNY demand “lift” out of the first quarter.

8. Asia Channel Inventory. We expect Asian component distributors to exit the fourth quarter with inventories 15 to 30 days (Bluefin Research estimate) above target levels based on our industry checks, creating a headwind for suppliers who recognize revenues on a sell-in basis to the channel as these distributors work their inventory levels down to target levels in the March quarter.

9. 100% Bonus Depreciation Expires. The Tax Relief Act in the U.S. provided 100% bonus depreciation for eligible property placed in service before January 1, 2012. This bonus depreciation drops to 50% next year. Our polling suggests that many small businesses took advantage of this benefit, and in many cases pulled in their hardware needs from early 2012 into their 2011 year-end spending budget flush.

10. Cautious Customer Behavior. Typical semiconductor cycles see customers transitioning from inventory depletion mode to inventory accumulation as demand firms up and component lead times extend. This procurement transition typically causes component demand to far exceed end equipment demand in an up cycle. However, semiconductor lead times are extremely short right now and customer visibility remains very limited, while demand has yet to firm up. In addition, customers remain wary of a negative outcome to the ongoing debt crisis in Europe. As a result, we expect customer buying behavior to remain very conservative, exercising lean inventory management practices while industry lead times remain low.

Source: 10 Reasons Semi Sales Will Be Sub-Seasonal In Q1