by James Montgomery, news editor
August 9, 2010 – Recent checks into Asian devicemaker and subcon sectors are raising the spectre of building inventories up and down the supply chain, which could slap a "triple whammy" on companies’ expected revenues and profitability.
Inventory concerns have started popping up elsewhere with suggestion that supplies have overshot estimates in some segments and will necessitate a pullback. (Others say careful inventory management is still keeping 2010 "beefy.")
Now there’s another point of concern about inventories, attached to one important industry metric: Days of inventory (DOI), which is creeping up all across the supply chain, from chipmakers to distributors to backend firms (EMS), as well as OEMs for key devices (PCs, handsets, communications equipment). Total supply chain inventories grew 10% in 2Q, about five points more than was expected, claims Craig Berger from FBR Research; DOI for global electronics in general is now 17% higher than its all-time trough (3Q09). "Downstream customers no longer replenish inventory and could begin to de-stock inventory," he warns, which will end up denting revenues and profits further back in the chain.
|Summary of change in 2Q DOIs by market segment. (Source: FBR Research)|
So what’s behind the DOI numbers in each sector?
– Chips: Fabs are "likely running hot" to build up inventory to support perceived customer demand, but the magnitude of the buildup (in dollars) could pinch off gross margins. Chip inventory DOIs "are still reasonable," he says, at -17% below norms from late 2007 and early 2008. But both DOI and inventory dollars both grew worse than typical in 2Q.
– Distributor and EMS: Distributor DOI rose roughly 20% in 2Q, and its inventory dollars spiked "a somewhat alarming +18% sequentially" vs. typical Q/Q inventory dollar growth of 2.5%, Berger notes. Inventory dollars for contractors (EMS) likewise grew more than expected (11% Q/Q). Both sides are rapidly replenishing their inventories to support downstream demand, but the pace of sequential growth is likely not sustainable, which is bad news for the chip firms sending them product.
– OEMs: At the end of the chain, PC hardware DOIs were flat and "still healthy" (thanks to just-in-time inventory controls processes), while handset inventories are "also healthy," Berger notes.
Also keeping track of the inventory build is Credit Suisse’s John Pitzer, who based on visits with ~20 Taiwanese companies (from foundry/fabless to substrates to motherboard makers), sees a clear division: "a bullish trendline" for general enterprise, industrial, wireless, smartphones, and anything tied to Apple. But importantly, he notes, "the PC food chain at the very least is off to a slow start." Several PC OEMs have cut back their build plans, though it’s too early to tell whether this is a repetitive mid-quarter shift or something more permanent. Monthly sales seem to have "bottomed out in July" with no expected pickup until September, he writes. Nevertheless, he sees no reduced build plans for corporate PCs; less impact to European sell-through; and signs of improving channel activity in China. Weakness seems concentrated to the US consumer channel.
"Our bullish view on the semi cycle has been a supply call against the backdrop of a somewhat agnostic demand view," he writes, and "our view on supply has not changed" — cyclically slower growth in supplies, in addition to reduced expectations for memory bit growth, yield issues at advanced chipmaking nodes, and higher capital intensity as companies press to add capacity.
Interestingly, Pitzer says he sees a coming surge in capital intensity. In recent years, capital expenditures vs. sales has it’s sunk to the low-teens percentage, but Pitzer believes that’s "headed back to 20% plus, reversing a 7-year period of easy supply growth and excess capacity."
Deutsche Bank’s Ross Seymore, though, thinks fears of inventory build are "overblown." Inventory indeed has risen for three consecutive quarters, but rather than building to excess it is "simply in the process of returning to ‘normal’ levels" and is "lean by any historical basis," he points out in a research note — 13% below its 2006 peak even though sales today are ~20% higher. He sees the same equation further down the channel too; semiconductor "customer" inventory rose 11% in 2Q but is still -15% below its prior peak levels, on just -4% lower sales.
Supply may not warrant our concern, though demand might yet have a role to play, Seymore says. Macro demand "is likely to remain choppy," though still seasonally normal for the rest of 2010. "If our assertion regarding lean inventory is correct, then risk to semiconductor estimates primarily resides on the demand side of the equation and semi companies should grow in-line with their customers," he writes.