Indicators hint at an upturn in the equipment industry
12/01/1998
Indicators hint at an upturn in the equipment industry
Timothy W. Summers, Advest Inc., Hartford, Connecticut
Semiconductor equipment companies are in the grip of an industry downturn the likes of which have not been experienced in over a decade. Many companies are reporting quarterly losses and have announced restructuring or downsizing. Stock prices have been under extreme pressure. While rallying in the earlier part of 1998 on the expectations of a second half recovery, these hopes have now been dashed. Virtually every company in the industry sees no upturn in sight and indeed, some companies say that their business has yet to hit bottom.
These difficult conditions are attributed mainly to three factors: the increasingly difficult economic conditions in the Far East, production overcapacity particularly in DRAMs, and increasing demand for sub-$1000 PCs combined with PC manufacturers` desire to reduce inventories. These factors are continuing to cause customers to push out or cancel equipment orders. Purchases of equipment for semiconductor production capacity additions are nearly nonexistent, while equipment purchases relating to the acquisition of new technology are becoming increasingly selective. Production overcapacity has put a severe crimp in spending of any kind.
As bad as the industry fundamentals now appear, there are some rays of light shining through the black veil. Certain indicators suggest that the semiconductor industry may be in the early stages of a cyclical recovery. Presuming that the historical correlation between the direction of the semiconductor industry and the equipment industry continues, the equipment industry may be close to a cyclical bottom.
A look at the indicators
Many data points illustrate the magnitude of the current equipment industry downturn. Data provided by SEMI estimate the bookings and billings for North American equipment suppliers. Although the data only apply to North America, they are symptomatic of the worldwide situation.
After peaking in the July-October 1997 time frame, orders and billings have weakened considerably. For the three months ending August 1998, orders for fabrication equipment were reported to be $632 million, while billings were $1.06 billion, equating to a book-to-bill ratio of 0.60. As Fig. 1 illustrates, booking and billings have declined 62% and 35% from their respective 1997 peaks.
Furthermore, September orders appear to be weak. Comments from many equipment companies, both systems OEMs and their respective component suppliers, suggest that 3Q98 orders will be weaker than those in 2Q98, and that orders have weakened as the quarter progressed.
Continued cuts in capital spending plans by the major global semiconductor manufacturers can weaken additional orders. Capital spending was expected to rise in the mid-teens rate at the beginning of this year. At mid-year, the rate declined 2%, and now is forecast to decline 22% year-to-year (presuming that spending for wafer fabrication equipment rises and falls the same amount as total capital spending). As pessimistic as this seems, several large equipment OEMs are forecasting that spending could decline as much as 30% from year to year, and none are stating definitively that the cyclical bottom has been reached. Japanese and South Korean companies` spending plans are most affected, with their semiconductor production highly skewed to DRAMs.
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Figure 1. North American semiconductor equipment bookings & billings (3 months moving average).
Production overcapacity remains rampant
Production capacity and capacity utilization are key variables in forecasting equipment demand. No matter how positive things are in the semiconductor industry, if there is excess production capacity, there is little need to purchase incremental production equipment.
The industry was running through October 1997 at a capacity utilization rate of roughly 90%, which is optimal for this industry. Any lower, and capacity sits idle; any higher, and the fab economics experience a serious case of diminishing returns. As the Korean financial crises unfolded and PC inventories started to rise, IC production slowed. Capacity utilization started its free fall in December 1997, plunging to 79% by February 1998. Since then, numerous fabs have been temporarily closed; some shut down completely; and many that were on the drawing boards have been put on hold. Current industry capacity utilization has bounced between 79 and 85% for the last eight months (Fig. 2).
Even with the physical plant capacity reductions, estimated IC capacity, as measured in millions of in.2, has declined only 4%, due in large part to successful shrink programs by the major DRAM and logic IC manufacturers, which have accelerated in the past year. These programs can markedly increase incremental profitability, since a small increase in cost results in a large increase in revenue.
It may take up to a year or more for the industry`s capacity utilization rate to approach 90%. DRAM capacity utilization is running in the 70% range, and overcapacity is concentrated within these products. DRAM bit demand is growing 70%/year, while DRAM capacity is increasing at about 30-50%/year. Presuming that these rates of growth continue, this excess capacity would be absorbed in about twelve months, and a sustained cyclical recovery in production equipment spending for the DRAM market could begin by 4Q99. The overcapacity issue in non-DRAM markets does not appear as serious. Those markets could return to a more normal supply demand balance by mid-1999.
Light at the end of the tunnel?
Over the long run, trends in the semiconductor and semiconductor equipment industries run in tandem. Over the short run, trends in the two industries occasionally de-couple. The de-coupling tends to occur because the semiconductor industry tends to be influenced by events that can change quickly, such as spot market pricing, which can change daily; while the semiconductor equipment industry tends to be influenced by long lead time issues, such as construction of multibillion fabrication facilities. Even though indicators from the equipment industry are still negative and perhaps getting more so, several semiconductor industry indicators are emerging as bright spots in an otherwise dark environment. While these changes have only recently surfaced, they can be taken as positive signs of leading indicators of a cyclical upturn in the semiconductor capital equipment industry.
The DRAM pricing environment is improving, suggesting that the supply demand imbalance may in fact be coming back into balance. Firming spot prices have become evident in a number of industrialized countries around the world. An economic recession in the US, however, would clearly delay the inevitable upturn. n
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Figure 2. Worldwide semiconductor capacity and capacity utilization.