Inventory Buildup Underway

Four months of higher semiconductor shipments signal an industry turn to inventory building that should last well into 2006 and then evolve into a new period of inventory cutting. This means a pickup in production equipment orders early in the year and a fall-off later. This parts inventory cycle, within a broader economic cycle that remains strong, is the inevitable consequence of a capital-intensive industry with a disaggregated manufacturing process over multiple sites, even multiple countries. Any small error in semiconductor demand planning has already initiated a significant change in production before the error is realized and can be corrected.

Semiconductor shipments jumped 6.5% in the four months through November, compared with the previous year. That is a nearly 20% annual growth pace — far faster than the increase in final demand for electronic products. As a result, the semiconductor inventory is rising from the end of the fabline through the balance of manufacturing and distribution and into end products. TSMC reports that its shipments rose 60% from February to November, and projected 100% capacity operation by the end of 2005. Semiconductor production in the United States is now 23% higher than a year earlier, but U.S. electronic factory shipments have an increase of <6%. Some of this gap is in the differences in the measurement process for sales and production, but much of it represents inventory restocking. Also, with the average selling price of ICs dropping more than 20 cents from earlier in 2005, the physical inventory accumulation is larger than the surplus of sales revenue over final-demand sales.

Source: U.S. Census Bureau

Inventory measurements, crude as they are, are already showing inventory building in electronic manufacturing while inventories remain at a record lean level in the rest of manufacturing, as well as in distribution. The inventories of U.S. electronics manufacturers have edged up to 1.24 months of sales in November from 1.19 months in August. This is one day plus of additional inventory. This does not seem like a worrisome increase yet, but within six months, it is inevitable that downstream buyers will collectively realize that they are overstocked and cut orders.

The electronics inventory trimming later this year will coincide with the projected slowing of world economic growth from a little over 4% to a little under 4%. Near 4% economic growth is more than enough to cushion the weakness in the electronics market and keep the impact as minimal as the last period of inventory reduction in late 2004 and early 2005. The Asian suppliers concentrated in parts for entry-level consumer electronic products sold in rapidly expanding developing countries will fare the worst, because the inefficient distribution in these countries will give them less warning.