PREMIUM SEARCH Search by job title, geography and build a list of executive contacts
The semiconductor industry was supposed to show a smooth recovery this year and then race ahead in 2003 and 2004. As sales started picking up earlier in the year, many industry watchers figured the next cycle would peak in 2004-05. However, the mending in 2002 is turning out to be a slower process than expected.
The March quarter was indeed fairly strong, but the June quarter was mixed, and September's looks weak. Most of the chipmakers that Standard & Poor's covers have issued low guidance for third-quarter revenues and earnings, even if they met their second-quarter quarter goals.
While many of the makers of analog, discrete, and logic chips used in DVD and CD players and aimed at the consumer market, did hit June targets for sales and earnings, PC-oriented chipmakers and producers of logic chips for wireline communications equipment tended to warn and miss on both counts. Chip stocks fell dramatically in June and July, and since then the group has been trying to rebound.
MUTED EXPECTATIONS. The trouble is, lackluster sales in key end markets, such as personal computers and wireless phones, and moribund demand for telecommunications equipment, have spoiled chip sales during the summer and threaten the December quarter, too. Although sales growth usually picks up late in the year, expectations are muted since economic forecasts have been trimmed back, and consumer sentiment has fallen.
The latest outlook from the industry's main trade group, the Semiconductor Industry Assn. (SIA), estimates worldwide sales of semiconductors to rise a modest 3.1% in 2002, after falling 32% last year. But given the slowing since June, this forecast now looks like a best-case scenario.
The longer-term forecast is much brighter. The SIA sees healthy sales growth of 23.2% in 2003, and an additional rise of 20.9%, to a new record level, in 2004. After that, the SIA sees flat growth of 0.9% in 2005 chip sales, presumably reflecting the notion that a slowdown based on overcapacity is likely to evolve about every four years based on historical industry trends. Given the weaker economic forecasts since the SIA's prediction came out, its forecast now looks optimistic.
SOFTER DEMAND. A key measure to watch is quarterly global chip sales, as tracked by the SIA (see table). The cycle hit bottom in the fourth quarter of 2001. Sales improved in the first and second quarters this year and should pick up in the final quarters, given the typical seasonal strength from back-to-school and holiday tech purchases. However, hopes for a boost in coming quarters have faded following the soft consumer demand in the summer months.
Worldwide Semiconductor Sales
$ Bil.
2001: Q1
43.24
Q2
34.62
Q3
30.56
Q4
30.54
2002: Q1
32.20
Q2
34.05
Q3
36.86*
Q4
40.40*
Source: SIA's World Semiconductor Forecast 2002-2005 (June 2002); * estimate
What's more, while unit volumes have been fairly strong (up 19% in the second quarter of 2002 from the previous quarter), revenues have been hurt by lower average selling prices (ASPs fell 11% sequentially in the second quarter). If third-quarter unit sales slow, chip pricing is unlikely to improve.
S&P expects overall chip prices to remain soft into 2003, as supply continues to outstrip demand. When pricing does firm, chip stocks should scoot higher. The crossover should become apparent when lead times on orders begin to lengthen. But the industry isn't there yet.
FADING APPETITES. Meanwhile, spending on capital equipment to make chips is slowing down after a growth spurt in the first half of 2002, mostly in reaction to cooling consumer demand for electronics. A good gauge for this is the book-to-bill ratio for chipmaking gear from the Semiconductor Equipment & Materials International (SEMI) industry association. The SEMI book-to-bill was rising for several months before retreating in July (see table).
A book-to-bill ratio above 1.0 indicates more bookings (orders) than billings (shipments), and therefore an expansion in the industry. It's a proxy for chipmakers' eagerness to increase wafer-fabrication plant capacity to meet demand. The table below shows that orders for chip equipment steadily recovered in the spring, but then softened in July. So right now, chipmakers' appetite for adding capacity is fading.
North American Semiconductor Equipment Book-To-Bill Ratio
3-month moving avg.
Feb. 2002
0.90
March
1.05
April
1.22
May
1.27
June
1.26
July (preliminary)
1.16
Source: Semiconductor Equipment and Materials International
Bellwethers Intel (INTC
, ranked S&P 2 STARS, or avoid) and Taiwan Semiconductor (TSMC
) recently announced cutbacks in capital-spending plans for the rest of the year. TSMC sliced its to under $2 billion for 2002, from a prior forecast of $2.5 billion. Meanwhile, Intel lowered its plan to between $5 billion and $5.2 billion from $5.5 billion. The more bearish pundits speculate that another round of capital-spending cuts might occur if back-to-school sales of electronic goods are weak.
Another useful industry barometer is capacity utilization at wafer-fabrication plants. Utilization hit bottom in the third quarter of 2001, when 64.2% of chip production capacity was in use. Since then, utilization has steadily increased and reached 86.4% in the second quarter.
SHARING THE PAIN. However, many observers speculate that this progress might stall in the third quarter as many chipmakers sense slowing demand. Taiwan Semiconductor, the world's largest semiconductor manufacturer working solely to produce chips for other companies, recently said it expects its capacity-utilization rate to ease in the third quarter because shipments were not likely to be as strong. TSMC's patterns are a good proxy for the broader industry.
The sagging conditions of the major electronic-components distributors are yet another confirmation of slowing chip sales. On July 26, S&P Ratings Service put its ratings for Arrow Electronics (ARW
, 2 STARS) on CreditWatch with negative implications. The same day, Moody's Investor Service put its ratings for Avnet (AVT
, 3 STARS from S&P, or hold) under review for a possible ratings downgrade. Current low revenue streams reduce the distributors' ability to cover debt payments easily.
Despite all the negative vibes, S&P views the summer slack in chip sector fundamentals as a brief break in a multiyear industry expansion. The long-term demand driver -- increasing use of semiconductors in more applications -- is firmly in place. Short-term factors, such as a slowing of economic growth for a quarter or two, can prolong a phase of the sector's cycle. But eventually, demand should catch up with supply and create a cycle climax that's worth investing in.
NAMES TO WATCH. Although we at S&P are currently recommending an underweight position in the technology sector, we do like some chip names. Valuations are much more attractive than they were last spring, but not all chip stocks have hit historical low valuation points.
Microchip Technology (MCHP
) is the only chipmaker that S&P ranks as 5-STAR (or buy). Microchip focuses on microcontrollers and associated analog and specialty memory chips. It's in the process of buying a used wafer fab at a very low price, which should help boost gross margins as the expansion progresses. MCHP is a Power Pick for the year and is in S&P's Top Ten portfolio.
Our 4-STAR (or accumulate) picks come mostly from the analog, programmable logic, and discrete semiconductor areas. They are Linear Technology (LLTC
), Maxim Integrated Products (MXIM
), Analog Devices (ADI
), Xilinx (XLNX
), Fairchild Semiconductor (FCS
), Vishay Intertechnology (VSH
), and International Rectifier (IRF
).
Analyst Smith follows semiconductor stocks for Standard & Poor's
Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
Get BusinessWeek directly on your desktop with our RSS feeds.
Add BusinessWeek news to your Web site with our headline feed.
Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.
To subscribe online to BusinessWeek magazine, please click here.
Copyright 2002, by The McGraw-Hill Companies Inc. All rights reserved.
Printer-Friendly Version
