Capacity Additions and Inventory Stocking Expected Through Next Summer

Capacity utilization at semiconductor fabs has probably risen to well over 90% late in 2005, spurred by a 13% jump in IC unit production from May to August, with further increases into the fall. Higher semiconductor demand is coming with world economic growth still very strong.

This completely changes the market environment that prevailed during the past year, when capacity utilization dipped to <80% for foundries and averaged 88% for all fabs. Both sales unit volume and average selling prices are now rising, providing both circuit designers and fab operators with more revenue, but also raising the cost and stretching the delivery lead time of chip buyers.

The fab operating rate was 88.8% in the second quarter, according to SICAS. Since then, the SIA has reported that IC unit shipments in August were 6.8% higher than the second quarter average, almost certainly a larger increase than capacity additions, which have averaged 2.3% per quarter over the last year. Capacity additions are lagging because the shipments of semiconductor production equipment — primarily wafer processing — have dropped sharply since early in 2005. SEMI reports that shipments by North American-based manufacturers fell 17% from February to August. The decline in shipments was even deeper for Japanese-based manufacturers.

The fab capacity utilization percentage will remain solid in the 90s until next summer. It will take that long before the jump in equipment orders that began early in 2005 results in enough new capacity to convince chip buyers that it is again safe to stop stockpiling parts and begin to reduce parts inventory. Semiconductor unit shipments will rise faster than the consumption of semiconductors in end products. This has already begun. Parts shipments expanded at a 50%+ annual pace in the three months ending in August. This is 3-4× more than the increase in the number of parts installed in end products over the same period.

Every inventory cycle also comes with a downphase. The current surge in capacity building and parts stockpiling will lead to a period of capacity investment cutback and parts inventory reductions late next year and into 2007. This cycle is likely to peak with less overbuilding and overstocking than the last one, because it began at a higher level of facility utilization.

The swings in capacity investment and utilization, as always, will be larger for foundries than for integrated semiconductor manufacturers. This is inevitable, given foundries' chosen role as second-source suppliers and as the primary builders of the custom parts for hot new products. Already, TSMC had experienced a 34% rise in sales revenue from February to August, and has announced an increase in 2006 capital spending.