Q1 Chip Inventory Surge No Cause for Alarm

By Rosemary Farrell, iSuppli -- Electronic News, 4/28/2006

Although semiconductor inventories throughout the electronics industry swelled by a faster-than-expected rate during the first three months of the year, overall stockpiles remain lean and the supply chain continues to be healthy, according to an updated preliminary estimate from iSuppli Corp.’s Semiconductor Inventory Tracker service.

Semiconductor inventories in the electronics supply chain ended Q1 at a level amounting to $50 million less than the optimal target amount for chip stockpiles, according to the new preliminary estimate. This compares to an $844 million shortfall in the fourth quarter of 2005, totaling a $794 million increase in chip stockpiles during the first three months of 2006.

iSuppli previously predicted the supply chain would end Q1 with a shortfall of $400 million. With inventory just $50 million shy of the target, chip supply and demand appear to be nearly in balance.

The figure presents iSuppli’s estimate of excess semiconductor inventory in the electronics supply chain, including our updated preliminary estimate for Q1.

While overall semiconductor inventories lurk slightly below the optimal level, the chip makers themselves continue to hold more supply than required. The main reason for this is that they are compelled to build larger stockpiles in order to compensate for underweight inventories throughout the rest of the supply chain.

Semiconductor suppliers are expected to operate with inventory levels higher than their ideal targets throughout 2006. Thanks to these elevated supply levels, the semiconductor suppliers will remain beholden to their customers in terms of pricing and visibility until after the end of the second half of the year, iSuppli predicts.

Looking at stockpiles in other nodes of the supply chain, distributors also increased their chip inventory levels in Q1. However, distributors are operating with historically low stockpile levels, and despite the inventory replenishments, these companies remain in a state of undersupply. As with most chip customers, distributors are reluctant to place orders in the face of moderate expectations for demand.

On the demand side, the majority of end markets followed normal sales seasonality in the first quarter, meaning that demand softened compared to the peak period in the fourth quarter. However, some products, such as MP3 players, performed more strongly in the first quarter than expected.

The consequence of this Q1 slowdown is that parts formerly in tight supply now are readily available. Customers remain cautious about placing orders, even makers of end products that experienced growth in the March quarter. There is little evidence of panic and double ordering at this time.

Although the supply chain experienced some lead-time stretching and firming of prices in Q1, customers are holding off from full-scale restocking. Mixed and declining macroeconomic trends and large available inventories at suppliers are restraining customers from aggressively placing orders. The ongoing tightness in back-end supply constraints also is helping to limit excess shipments into the supply chain.

With sales on the rise in Q2, the supply/demand situation is expected to reach a balance by mid 2006. However, demand is expected to cool down in most markets in 2006 compared to 2005, with worldwide electronic equipment revenue expected to rise by 5.9 percent this year, compared to 7.8 percent last year.

About iSuppli’s Semiconductor Inventory Tracker Service

iSuppli defines excess inventory as the point where Days of Inventory (DOI) exceed historical averages during a quarter. The Semiconductor Inventory Tracker Service employs quarter-ending inventory levels for approximately 100 companies at every node of the electronics supply chain, i.e. foundries, integrated device manufacturers, distributors, OEMs, contract manufacturers and system distributors.

iSuppli then compares this information against target levels for each point in the chain by analyzing historical seasonal patterns and surveys of the companies to determine the desired level for inventory. We now do this at the total semiconductor level.

All DOI calculations are based on cost of goods sold, except for semiconductor suppliers, which are calculated on a cost-of-sales basis. For each segment, and for the entire supply chain, iSuppli then calculates what those extra days of parts lingering in inventory are valued at during the quarter based on the target levels.

Rosemary Farrell is an analyst for iSuppli Corp. Farrell’s upcoming report, Inventory Tracker—Q2 2006, from iSuppli’s Inventory Tracker service, presents detailed research on the state of semiconductor stockpiles in the electronics supply chain.