Wednesday, February 16, 2011

Chip Inventories Manageable? Wait To Buy, Says JP Morgan

Tidbits from the semiconductor world — Analog Devices’s (ADI) Q1 conference call last night, for example — have brought encouraging signs that an inventory correction in chips late last year is resolving itself in short order.

But watch out, say the folks at research firm iSuppli. Chip analyst Sharon Stiefel notes this afternoon that semiconductor inventory held by the chip makers themselves surged to a two-and-a-half-year high in Q4 of last year, at 83.6 days of inventory, up 7% from Q3’s level of 78.1 days. The last time inventory was this high was in Q2 of 2008, right before the downturn, Stiefel notes.

Inventory levels arguably now are high by any standard, illustrating the difficulty of controlling chip stockpiles even with semiconductor suppliers’ arduous efforts to keep them in check. The sharp increase of semiconductor inventory during the fourth quarter defied expectations of a decline for the period. This inflated level of inventory could become a concern if semiconductor industry growth falls short of expectations in 2011.

For the moment, at least, the forecast for this year for 5.6% semiconductor revenue growth should make the surge in inventory “manageable,” Stiefel believes.

But manageable, for an investor, may mean waiting a bit, says JP Morgan chip analyst Christopher Danely.

Danely today writes that total semiconductor industry factory utilization rate in Q4 was 93.1%, down from 95% in Q3, but still above his expectation for 89%, as capacity rose 4% in the quarter, which was higher than the normal seasonal increase of 1% that’s typical in Q4, and demand rose 2%.

He thinks utilization’s probably about the same this quarter, but will rise to 95% in Q2, as capacity rises 3% and wafer demand rises 5%.

What does all that mean? “We expect many semiconductor companies to capitulate and lower utilization rates over the next few months as it becomes obvious that production rates and inventory are too high,” given that bookings growth in Q4 declined generally. “As a result, we expect reductions in gross and operating margins which lead to a reduction in Consensus estimates.”

That means, he writes, that, “The best time to buy semiconductor stocks is [...] after semiconductor companies lower utilization rates, which generally sets in motion a fundamental bottom as it usually means most of the negative earnings revisions have occurred. We expect this to happen some time during the first half of 2011.”

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