Semiconductor Suppliers Feel Chill

Semiconductor equipment orders have declined in the United States and Japan, according to data released last week, and those numbers look worse in light of the elevated inventory levels that have clogged the semiconductor supply chain for months.

Moreover, global economic growth may be slipping. One analyst has even used the dreaded "R" word to describe the worst possible consequence of lower orders and higher inventories.

"At the very least, we're going to see a softening of prices. The worst case is, we have a recession," said Stephan Ohr, research director for analog semiconductors at Gartner Dataquest. Asked to elaborate, Ohr said that the firm expects a 10.9 percent increase in worldwide semiconductor revenues this year but that 2007 is looking fuzzy.

"The current inventory build and the softening of orders are a bit worrisome, especially in the resemblance to 2004 conditions," Ohr said. "But most of the analysts I've talked to believe the inventory will burn off, and we won't see the same revenue trough that we did in early 2005."

"The global growth cycle may be close to its peak," Rodrigo de Rato, managing director of the International Monetary Fund, told the IMF board of governors last week. The continuing productivity improvements and new technologies that have assisted global growth "may be diminishing," he said. While "solid and broad-based growth" is expected in 2007, "in the United States, the speed of expansion appears to have moderated."

A slowdown in the United States would have a "significant impact" on emerging East Asian economies, the IMF states in its "Regional Economic Outlook for Asia and the Pacific" report, which warns that the electronics industry is losing clout as an economic driver. In addition, recent trade numbers "show a drop in China's tech imports, reflecting a correction in inventories that had been accumulating since the second half of last year," the report states.

"We believe there are some inventory issues that the integrated-circuits industry will need to work out," Bill McClean, president of IC Insights, said in a Web conference last month.

IC unit volume shipments increased 25 percent in the first half over the year-ago period, exceeding the industry's 9.5 percent historic unit growth rate, McClean said. In 2004, unit volume shipments were 8 percentage points above the industry's long-term trend line. That led to inventory adjustment through late 2004 and early 2005.

Concerns about excess semiconductor shipments initially focused on PCs, but McClean said inventory is rising in other areas too. But, overall, IC Insights does "not believe there is an excessive amount of capacity being built up," McClean said.

Of course, all bets are off if the U.S. economy spirals into recession. Merrill Lynch believes the U.S. GDP will slow to 1.9 percent in 2007. That would be down from the 3.4 percent growth expected this year but slightly higher than the 2.5 percent GDP growth posted in 2004-and in 2004, chip consumption grew 14 percent.

The point is that "the impact of the GDP on the IC market isn't 1 to 1," said Moshe Handelsman, president of Advanced Forecasting Corp. "Though this correlation was very strong during the 2000-2004 period, it didn't hold prior to or after it. Therefore, we aren't as pessimistic about the near-term future of the IC market."

Despite its cautionary tone, the IMF points out that Asian GDP will still ring up growth of 7.3 percent this year and 7.1 percent next year, as exports moderate. Asia may be able to pick up some of the slack of slowing U.S. and European economies.

But the semiconductor equipment book-to-bill ratios released last week signaled slowdowns in Japan as well as the States. Semiconductor Equipment and Materials International (SEMI) said North American-based manufacturers posted a ratio of 1.00 in August, down from 1.06 in July and 1.14 in June. A ratio greater than 1.00 indicates expansion; a ratio of 1.00 means that orders booked that month by equipment suppliers essentially matched billings. The SEMI ratio is a three-month moving average, which softens seasonal swings.

The three-month average of worldwide bookings in August was $1.73 billion, flat with July but almost 57 percent higher than the $1.10 billion in orders posted in August 2005. The three-month average of worldwide billings in August was $1.74 billion, more than 6 percent above July's $1.64 billion and 65 percent above the August 2005 billings level of $1.06 billion.

Stanley T. Myers, SEMI's president and CEO, said in a statement that North American equipment makers "posted the highest billings level since March 2001, while bookings remained even. Overall, both bookings and billings are trending as expected for the cycle, with 2006 being a strong growth year for the industry."

Recent figures from SEMI call for a slowdown in equipment sales next year, however, despite analysts' predictions of growing chip sales.

Japan-based makers of semiconductor gear posted a book-to-bill for August of 1.16, down from 1.30 in July and 1.52 in June, according to preliminary data from the Semiconductor Equipment Association of Japan.

Several companies recently lowered sales forecasts for the current quarter. National Semiconductor Corp., a $2.2 billion chip maker, said this month that bookings for its first fiscal quarter, ended Aug. 27, were 13 percent lower than the prior quarter's tally, partly because of lower orders from distributors. It also said it expects revenue for the second quarter to fall 2 to 5 percent from first-quarter levels because of a decline in foundry revenue.

Rosemary Farrell, an analyst with iSuppli Corp., called current inventory levels "quite elevated" and said the situation is "probably similar to what we saw in 2004." Concerns over excess inventory are valid, she said, though suppliers are divided over its meaning.

"Over half of [the excess industry inventory] is explainable by Intel," Farrell said, adding that she'd be more concerned if she didn't know its source. Various analysts who believe much of the industry malaise lies with Intel cited a massive buildup of CPUs in the channel, though PC sales should see double-digit sales growth this year.

Semiconductor inventories increased 18.6 percent in the second quarter at publicly traded electronics-manufacturing-service providers, led by Flextronics, with a 29 percent inventory spike, and Jabil, with a 24 percent increase. EMS providers are responsible for 10.3 percent of the excess semiconductor stockpiles in the electronics supply chain, according to an iSuppli newsletter published earlier this month.

"While the sudden increase of inventory appears to be manageable, the situation could worsen if end-market demand does not follow through in the second half," iSuppli senior analyst Adam Pick wrote.

Third-quarter financial results could set the tone for the remainder of the year. Corporate profits were down overall in the second quarter as inventory concerns heightened, causing a sell-off in technology stocks. The Philadelphia Semiconductor Index (SOX) pitched from a high of 551 in January to a low of 384 in July. Since then, many tech stocks have bounced back, and today the SOX hovers around 450.

A few other data points will be worth watching in the coming months. DRAM pricing should remain healthy, driven by demand in cell phones and in PCs running Windows Vista. NAND flash is also projected to do well, fueled by sales of MP3 players, digital cameras and USB stick drives. VLSI Research Inc. said NAND flash shipments have been running 55 percent above the levels of 2005.

Analog components will rise in importance for emerging markets in consumer, automotive and medical gear, though Gartner Dataquest thinks growth will slow from 10.6 percent this year to 8.9 percent in 2007.

In displays, the IMF sees a "sharp slowdown" in thin-film-transistor panel shipments from Taiwan, but recent data contradicts that assumption. August TFT shipments were up 21 percent over July, and analysts expect strong demand to continue. That's boosting PC panel prices and stabilizing the price of panels for 32-inch LCD TVs as the holiday season nears.