October 1, 2006

"Demand" is strong, fabs are "full"...

(c) copyright View from Silicon Valley 2006.  All rights reserved.


The recent SOXX run-up has bulls proclaiming the inevitability of semiconductor stock price growth.  "Demand" is "strong," fabs are "full" which is "obvious" since "everybody" wants a new PC /plasma TV /cell phone /iPOD.  (Choose your own stereotype.)  Such headlines (and stereotypes) overlook some disturbing items emerging over the past week or so...

We culled a few recent news items from Barron's TechTraderDaliy blog.  (We aren't traders but we do recommend the blog.)

First up is, "Gartner Says Price Cuts Will Drive Double-Digit PC Unit Growth in 2006, But Revenue Will Decline."

The piece includes such gems as,
"Worldwide PC shipments are on pace to total 233.7 million units in 2006, a 10.5 percent increase from 2005, however worldwide PC revenue is expected to reach $198.3 billion, a 2.5 percent decline."
--Thus the average PC price declined -11.7%(! , from $961 to $849).  Keep in mind this double-digit(!) price decline occurred in the face of a historic shift to "high margin" notebook PCs.  What happens now that everyone who wants a notebook has one?  (Who is left that wants one but doesn't have one?)  

Who can grow profits in this environment?  Perhaps we should clarify, "Who can grow profits in this environment without more lay-offs and/or more offshore out-sourcing?"

followed by,
“Unit growth will continue to be price driven for the next several quarters as PC replacement activity wanes and the battle between Intel and AMD escalates,”

“Steeper PC price declines will spur unit growth in mature markets like the United States over the near term, but growth will eventually slow to mid-single digits in these markets as PC replacements fade and saturation becomes more problematic."
--Even if lower prices spur more growth, what happens to actual profits?  (And stock prices?)

And to answer your next question they added,
"We remain skeptical of Vista’s impact.” 
--Who is going to risk Vista early on if they don't have to?

OK, who cares about the PC makers?  The "real" money is in the CPU and operating system.  AMD is going to keep killing Intel, right?  Right??

Addressing exactly this point, we also found(*)
Merrill Lynch's "four predictions on Advanced Micro Devices (AMD), along with one warning about the stock."

"AMD’s share gain in server processors will continue unabated."
--Who is making big profits in servers these days?  (Please don't waste our time touting Sun...)

"AMD won’t get past 15% of the mobile processor market in 2007."
--Oops!

"Dell will give AMD less business than the bulls hope for the near term, but more than even the biggest bulls hope for over the the long term."
--Suggesting AMD has an even worse short-term valuation than is widely recognized in the market.

"AMD will allow ATI’s discrete GPU [graphics processor] business to slowly die."

But most important, in our view is their prediction:

"From valuation and earnings momentum standpoint, however, the stock does not make sense."
--Have the guys touting AMD over Intel actually run the numbers?

OK, but that's just PC's and CPU's.  Everybody knows those are mature, commoditizing markets.  The real money is in NAND and DRAM commodities.  Samsung, Micron and crew understand how to make money in commodities.

Well, maybe so, but also heard, "the DRAM market could be headed into an excess supply situation in the first half of 2007," according to Credit Suisse (**).

The same report hit our favorite under-reported news:
"(I)ncremental DRAM supply will create DRAM pricing and profit downside."

And also commented,
"The risk that weak NAND flash pricing will jeopardize upside from the company’s aggressive NAND ramp."

Just to focus on NAND for a moment, back in June, Barron's reported UBS saying (&):
"While he notes that the chip industry is dramatically building out new capacity for NAND flash memory chips - Guana sees bit growth of more than 180% this year and over 155% in 2007 - he expects demand to keep up... He also sees new demand emerging in handsets and notebook PCs. The bottom line, he says, is that NAND supply 'is well matched to 2006/07 net demand.'"

But now in September, the same guy is saying:
"(I)ncrementally less upbeat on NAND prospects given the exaggerated levels of pricing declines seen over the course of the year."
--Did these guys risk their own money based on their June-dated blather?  Did their clients?  Did they take money off the table before, or after, admitting NAND supply has exceeded demand in their September report?

We've been warning about NAND price problems for some time, as in:
"NAND prices still falling," April 28, 2006
http://www.viewfromsiliconvalley.com/id220.html

-and-
"NAND prices vs. iPOD sales", August 8, 2006 http://www.viewfromsiliconvalley.com/id246.html
(Stay tuned to View from Silicon Valley as we will soon update the charts.)

In case one concludes these are isolated incidents, we conclude with,
"Chip Stocks: “False Rally,” Says Think Equity; “Near-Term Risk,” Says Merrill" (@)

The highlights include:
"Major foundries indicated customers are building inventory."
--We wish they would say which customers.  Apparently, we have to wait until earnings season.

"We believe semiconductor companies are asking distributors to carry more inventory in Q3."
--This is the classic way to obscure semi inventory.  Watch Avnet and Arrow closely.

"Inventory levels may be understated on many balance sheets."
--We've been complaining about this subterfuge for years.  NOBODY can reliably track actual units in inventory in today's global supply chain.  This dispersion of parts may eventually be recognized as a risk, rather than a feature.

"Several sources believe this resembles the 2004 inventory correction…[which] lasted four quarters before demand again recovered."
--Given there is LOT more capacity on-stream today than in 2004, the severity of this downturn remains to be seen.

"For PCs, exuberant chipset and motherboard makers clash with grim OEM forecasts."
--The PC makers see a problem but it hasn't worked it's way up the supply chain yet.

"Almost everyone we have spoken with is concerned about weak PC and handset demand in [the second half], and a lack of concrete demand drivers in 2007."
--We do suspect video (and even TV) and/or the rumored iPOD phone might be a source of new cell phone demand next year.

"Analog companies are competing more fiercely for the high-volume sockets than they used to, which is putting pressure on margins."
--It used to be, even when the overall semi market was weak, you could count on analog companies to generate profits.  Apparently there no longer any safe niches for anybody in semis.

Did you see ANY of this news in your local paper?

Conclusion:
Weakness is evident is virtually every segment of the semi business. There is nowhere left to hide.

If you bought the SOXX, or equivalent, at 385 on July 21, you are to be congratulated.  As this is written the SOXX is 455, or +18%.

Could it go higher?  Of course.

If it does, will it be based on earning or fundamentals?  Will it be sustainable?  You can probably imagine our own opinion on this one.

* * * * *

The above is for entertainment purposes and is not intended as advice to buy, sell or hold any stock, bond, real estate nor any other financial product or service.  Buy and sell at your own risk (just like we do.)

* * * * *

*- http://blogs.barrons.com/techtraderdaily/2006/09/22/amd-four-predictions-and-a-warning-from-merrills-osha/

**- http://blogs.barrons.com/techtraderdaily/2006/09/26/micron-credit-suisse-cuts-rating-sees-possible-excess-dram-supply-in-2007/

&- http://blogs.barrons.com/techtraderdaily/2006/06/15/flash-news-why-nand-over-capacity-concerns-are-overblown/

&&- http://blogs.barrons.com/techtraderdaily/2006/09/13/micron-ubs-concerned-on-both-drams-nand-after-company-chat/

@- http://blogs.barrons.com/techtraderdaily/2006/09/25/chip-stocks-false-rally-says-think-equity-near-term-risk-says-merrill/