Semis With Highest, Lowest Production To Sales Ratio

For semiconductor manufacturers, production is represented by the semiconductors sold [COGS] and any change in inventory. Since the business has high operating leverage, producing more chips in any given period means each chip costs less. This in turn tends to boost gross margin when production levels are high.

The problem arises when the company is producing more than it can sell, which is what made me bearish on semiconductors over the last year. By comparing production to sell-through [COGS] it is possible to identify companies that have been producing more than they can sell and hence may see margins fall. It is also useful to identify those whose profits will rise because they need to increase production in order to meet demand.

Continuing my series on semiconductor inventory trends, I used Zacks Research Wizard to calculate production levels relative to COGS for nearly 40 semiconductor companies.

The five companies with the highest production levels relative to sell-through are Actions (ACTS), Cypress (CY), Monolithic Power (MPWR), Micron (MU) and MicroSemi (MSCC). These companies may face gross margin pressure as they wait for demand to catch up with production.

The five companies with the lowest production to COGS ratio are Applied Microcircuits (AMCC), PMC-Sierra (PMCS), Silicon Image (SIMG), Conexant (CNXT) and Anadigics (ANAD). These companies may see improving gross margin when they ramp production levels up to meet the demand and replenish inventory.

Special mention goes to Large Cap Watch List member MEMC Electronics (WFR), whose production levels have been insufficient to meet demand for seven consecutive quarters.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Comments

[Ralph F]

V. helpful article -- thanks.

Two questions.

You wrote: "For semiconductor manufacturers, production is represented by the semiconductors sold [COGS] and any change in inventory." Don't you mean revenue or sales, not production? Production is only goods manufactured, not net inventory sold.

Second, the main reason why a semiconductor company would produce less than its sell-through rate is if it is trying to reduce inventories. Yes, that probably points to rising gross margins in future, but doesn't it also imply that the company has a significant problem with inventories, and might have to write-down the value of those inventories if it can't sell them off?

[Frank Li]

Why would MEMC Electronics (WFR) be underproducing unless it was (a) trying to work off excess inventory, or (b) facing production problems?

[schmitt]

Trent:

Big error here. The production effect and the impact on gross margin applies only to companies that own their fab. Fabless companies do not see Gross margin move as 2000 wafers from TSMC costs the same as 1500.

You need to remove all fabless revenue to make this a meaningful study.

[WilliamTrent]

Ralph - I am comparing the amounts produced to the amounts sold to customers. If more is produced than is sold inventories will rise. If less is produced than is sold, inventories will fall. Too much inventory can be bad for future margins in one of at least two ways: 1) lower production, which due to operating leverage would mean each unit would have a higher cost; 2) obsolescence, which could lead to write-offs. Underproduction can mean lost sales.

Frank - You got two of the three potential reasons, with the other being a temporary shortfall (perhaps due to high seasonal demand or other factors.) In the case of MEMC, the prolonged underproduction is due to limited supplies of the raw material polysilicon. I would classify this as a production problem, but since it applies to all manufacturers it is not an MEMC problem. In fact, it is helping their margins since they are one of the few available sources.

Andrew - per my comment to Ralph, over/underproduction at fabless companies can impact margin through obsolescence or by missing out on sales if the inventory is not available. I think it is still worth looking at the trends for each company, although further analysis would require separating the companies into fab/fabless as well as other segments such as analog or memory.