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Contributors: Douglas McIntyre Jon C. Ogg

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Thursday, October 19, 2006

Semiconductor Makers Meet Harsh Reality

By William Trent, CFA of Stock Market Beat gives us these nuggets about the latest semiconductor equipment orders.
North American suppliers of equipment for making microchips reported September orders of $1.62 billion, down 6 percent from the previous month, further evidence that the industry cycle is slowing.The book-to-bill ratio was 1.00 in September, meaning that for every $100 of product shipped, $100 in new orders were booked, Semiconductor Equipment and Materials International said in a preliminary report.

The ratio is watched as an indicator of demand pipeline for the $40 billion global market for chip-making tools, complicated, expensive equipment that can take months to build and deliver.
The amount of equipment bought is also an indicator of capacity in the chip industry, and can give clues as to whether the sector is headed for a glut.

Clues as to whether the sector is headed for a glut? Hmm… where have we heard that before?
What is really interesting is when you look at the year/year growth rates for bookings and billings.

So here goes:
The two growth trends tend to follow the same pattern, which simply suggests that most of the semiconductor equipment ordered actually gets installed. Also, as would be expected, the order growth tends to lead the growth in installations. All of this explains why we look at the bookings rather than the billings as an indicator of semiconductor manufacturing capacity - even though it isn’t online yet, it will be. By looking at bookings we get the earliest possible signal of future direction.

The latest month, however, is something of an oddity. Although growth in bookings has slowed modestly for a couple of months now, the billings growth has suddenly shown a sharp decline. In fact, had billings growth slowed at the more moderate pace of bookings the book:bill ratio would have been significantly below 1.0. The reason, we believe, is that orders that had been placed for September installation were delayed.

As Intel said in its press release:
Capital spending for 2006: Between $5.7 billion and $5.9 billion, lower than the previous expectation primarily due to greater equipment reuse, productivity improvements and small timing changes.

It looks like they aren’t the only ones making “small timing changes” to their capital spending plans, and we also expect that the changes won’t stay small for long. Even with the current slowdown in growth, bookings are growing at 65% and billings at 50%, compared to just over 10% growth for the semiconductors themselves. Until the equipment orders more closely match the growth in the chips they will make, there will be a glut of semiconductors. The author may hold a position in the securities discussed.

A current list of the author's holdings is available here.

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