Another Inventory Glut?

Expect a slow Q4, but a much better 2015.

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For nearly a year, Semico’s IPI index has been indicating that the fundamental demand in the second half of 2014 would be seasonally weak. Back in early 2013, our initial view for 2014 was a 10% market growth. However, as the IPI declined in the second half of 2013 we revised our semiconductor revenue forecast down to 7.3% heeding the warning that was projected by the Semico IPI index. This write-up takes a look at scenarios and factors driving semiconductor sales for the remainder of 2014 and into 2015.

In addition to the IPI’s warning signal for the second half of 2014, our forecast incorporated lower growth rates for tablets and smartphones as compared to 2013. When looking at the new features provided by tablet and smartphone manufacturers, it appeared that there were no compelling new features to drive strong growth. As part of the normal pattern, we expected consumers to take a wait-and-see attitude just before new models were released. Many consumers have postponed their purchases this year, waiting to see what Apple and Samsung would offer. Of course, some consumers needed to upgrade due to loss, breakage or just because their phone was aging. Macroeconomic variables such as continued weakness in the overall economy and instability in the Middle East also added fuel to the downgrade. These factors were the primary drivers that compelled Semico to reevaluate its 10% growth forecast and lower it to 7.3%.

To date, we have preliminary worldwide semiconductor statistics through August 2014. If the IPI is correct, we should see below seasonal growth for the third and fourth quarters. At the current billing rate, third quarter 2014 will only grow 3.8% sequentially and 6.7% year-over-year. Third quarter 2013 grew sequentially 7.8% and 8.8% year-over-year. Taking a look at the first two months of the third quarter, July was down sequentially 7.7% and August was up 0.2%. July 2014 was an exceptional month; going back to 1997, only 2013 and 2009 had better sequential results. August 2014 on the other hand, was one of the worst sequential growth months with 2011 and 2012 the only years that had a smaller sequential percent change.

So let’s talk about “what-ifs”. If September 2014 grows sequentially in the range that it did in 2013 we will see a $33 billion September and a third-quarter sequential growth of 5.5%, still below the third quarter of 2013. But we’re already hearing about issues in the ecosystem. Microchip warned about weakness in its business, especially in China. Low-cost semiconductors may be at risk for a correction. At the same time, Intel is reporting strong PC demand, a market many vendors had de-emphasized. These contradicting reports add the fuel to turn OEMs skeptical and reduce inventories to improve their balance sheet for year-end financials. Such an inventory correction would create a fourth quarter with a sequential decline in revenue of 6.9%, producing an annual semiconductor revenue growth of 7.6%, still very close to the forecast Semico has been predicting for most of the year.

Is 10% growth possible? In order to reach 10% growth in 2014, October will have to experience the smallest sequential decline from September in history, and November will have to result in the highest sales we’ve seen since 2007. If December grows at an average rate of nearly 5%, that would produce a 10% growth for the year. While this is possible, our current belief is that it only holds a 30% chance of happening. In recent years, companies have been very reluctant to continue to build inventory in the fourth quarter and do not want to have overextended balance sheets. With the dampened outlook from companies such as Microchip and growing concerns of a weakening of the economy in China, a 10% growth seems even less likely. The most likely scenario still falls within the range of 7.2% to 7.6% for 2014.

The chart below shows the monthly semiconductor revenues through August with two dotted line scenarios for the remaining four months of the year and a look at 2015. We believe that 2015 has a strong upside compared to our recent forecast conveyed in the September IPI Report. Consumers delaying purchases and a strong IPI in early 2014 point to a strong first half of 2015. Even if the industry experienced a slight flattening of growth in the second half of 2015, the year would still end with a 10% growth as shown in the chart below.

Semiconductor Revenues by Month

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Source: Semico Research

In summary, semiconductors continue to be integrated into new devices and at higher content levels in almost every electrically powered product. The push to always be connected is transitioning to always being in control. Sensors and connectivity lead to more data, more processing and more semiconductors. This bodes well for a strong year in 2015.

For more information on the Semico IPI or any of the data presented in this write-up, please contact Rick Vogelei.