Semiconductor Sales Recovery Delayed Until Summer

Semiconductor sales are expected to improve modestly in the second half of 2005, with improvement continuing at least through most of next year. This turnabout will be driven by higher end-market demand, as well as by less surplus production capacity and inventory. The expected rise in sales will follow more than a year of sales stuck at a $220B annual pace, apart from normal seasonal variation. During this period, parts production counts were nearly steady and the average selling price of an IC stayed closed to the period average of $1.80.

While there were brief periods of both strength and weakness for the sales of most types of circuits, these were not sustainable trends but instead temporary adjustments to changes in demand, capacity and inventory in individual markets. Over the year-plus period, wafer-start capacity expanded about 6%, entirely in advanced process fab lines. Of this new capacity, 93-95% was used, but substantial surplus capacity developed on older process fab lines.

Sales did not fall as much as widely feared during the last year, because underlying economic demand was stronger than expected, especially in the United States and developing countries; however, the period of stagnant sales was longer than expected. Sharply higher oil prices get the blame for this. Energy prices prompted consumers to cut back vehicle purchases and trim spending growth for other durable goods. Manufacturers responded by postponing enough investment projects to half the pace of capital goods spending growth.

With oil prices falling in early May, consumer durable goods spending will be growing again by mid-year, raising semiconductor orders and production during the summer. Chip prices, however, are unlikely to see much improvement for several more months until the capacity utilization rate rises back above 95% at the newest, lowest unit cost fabs.

As a result, the recent buyers' market will evolve over the rest of this year into a balanced market, and then early next year, semiconductor manufacturers, including the contract fabs, will begin to gradually regain some pricing power.

There are two risks of semiconductor sales resuming growth more slowly or with a longer delay. First, there may have been more accumulation of surplus chip inventory in the first half of 2005 than now appears to have happened. Inventories are notoriously hard to measure, and often turn out to have been larger than first thought during a period of weakening sales. If so, both production volume and selling prices would take longer to resume growing.

Second, semiconductor manufacturers appear to have considerable "nearly ready" capacity from the recent boom in fab equipment investment spending. If this is brought online later this year in an attempt to build market share, selling prices will weaken further.