Consumer Weakness Drives Negative Outlook for Semiconductors in 2009
Published on: 4th December 2008
Debt ratings agency, Fitch says that its 2009 Rating Outlook for the semiconductor industry is negative due to a meaningfully weaker macroeconomic environment, resulting in lower revenues for all semiconductor markets and, in particular, PCs and mobile handsets, which represent nearly 60% of global semiconductor consumption. While the overall market will be lower, Fitch expects developing economies will experience lower albeit still positive unit growth.
Overall, Fitch expects global semiconductor industry revenues, including memory makers, to decrease in the high single digits in 2009 from modestly higher revenue growth in 2008. Excluding memory makers, which are more exposed to consumer electronics and experiencing severe pricing pressures, Fitch believes semiconductor industry revenues will decrease in the mid single digits. Fitch expects the more volatile semiconductor equipment industry will experience revenue declines in the high teens to low twenties.
While marking the industry's first revenue decline since 2001, Fitch does not expect decreases to be of the same magnitude as those of 2001 (~30%), although given the lack of visibility, Fitch believes there is more down- than up-side risk to current expectations. From a business and operating profile standpoint, Fitch believes semiconductor companies continue to be subject to the highest technology risk within the technology industry.
Consumer electronics lead semiconductors lower in 2009:
Consumer electronics, particularly PCs and cell phone units, which have been the catalyst for semiconductor expansion over the past several years, will drive the overall semiconductor market lower in 2009. Fitch expects PC units to be flat to slightly lower and mobile phone units to decline in the mid single digits for the upcoming year. While the increasing mix of sales into developing economies should continue pressuring overall ASPs, Fitch also anticipates some ASP pressure to be mitigated by growth in higher priced smart phones in developed economies.
Additionally, Fitch continues to believe that, as the sales mix of consumer electronics increases, quickly bringing new products to market has become a competitive differentiator for original equipment manufacturers (OEM), supporting Fitch's expectations for increased use of outsourcing partners for research and development (R&D), manufacturing, and packaging and test.
More aggressive responses to evidence of slowdown:
Fitch believes the semiconductor supply chain has become more responsive to evidence of a slowdown, which should mitigate some of the impact of a weaker demand environment. Given the lack of visibility, along with concerns regarding the potential severity and duration of the current downturn, companies throughout the supply chain have announced restructuring initiatives, mostly headcount reductions but also shutting or transferring production to lower cost regions.
Given the highly fixed cost nature of the semiconductor industry, Fitch expects there will be a lag in the impact of these actions and believes most programs, if successfully executed, will achieve targeted cost savings on an annual run rate basis by the end of 2009.
In addition, the semiconductor supply chain, including the equipment makers and distributors, have taken steps to reduce inventories, potentially resulting in cash generation from working capital and augmenting free cash flow. Investments into more advanced information systems, greater use of foundries and, as a result, less uneven in-house utilization rates, and increased inventory discipline by components distributors have enabled the supply chain to become more efficient in correcting pockets of excess inventory. While inventories remain at elevated levels, recent inventory imbalances have been corrected in one-to-two quarters, approximately half the historical time.
Outsourcing and restructuring improves free cash flow profiles:
Fitch believes outsourcing and business restructuring transactions planned for 2009 will strengthen the long-term free cash flow profiles of the companies involved, and potentially mitigate some expected profitability pressures for 2009. Both AMD and Spansion plan significant outsourcing partnerships, which Fitch believes will free capital to focus on design competencies and reduce cash burn rates from the associated R&D and capital spend. In addition, Fitch believes TI's and Freescale's planned divestitures of certain elements of their cellular handset chip businesses underscores the commoditization of this market and the increasing need for significant scale to support ongoing R&D investments.
As a result of these transactions and cost reductions, Fitch expects intermediate term profit and free cash flow margins will improve.
These trends support Fitch's expectations for the increased use of foundries and partnerships, resulting in foundries expanding their share of semiconductor production over the longer-term. In Fitch's opinion, onerous R&D and capital spending requirements will prompt additional semiconductor makers to pursue hybrid or 'fab-lite' manufacturing strategies and partner with foundries in the development of next generation process technology.
Importantly, Fitch continues to believe more use of foundries will result in a healthier supply and demand balance for the overall semiconductor industry, as foundries consolidate a significant amount of capital spending on leading-edge technology (required for cost effectively manufacturing high volume standardized products).
Memory makers remain the most volatile segment of semiconductors:
Fitch believes memory makers, mainly large integrated electronics companies who toggle between DRAM and NAND flash memory production based upon a dynamic demand environment, will continue to experience the greatest volatility. Despite curtailing capital spending in aggregate over the second half of 2008, the industry continues to suffer from excess supply that Fitch believes will be exacerbated by lower unit demand in 2009. Capital spending in 2009 for memory makers is expected to be down sharply from 2008 levels, which should begin driving modestly improved pricing over the near-term. Nonetheless, because of significant competition in this highly commoditized market and that the vast majority of production is manufactured for use in consumer electronics devices, gross margins will remain thin, driving ongoing investments in leading-edge manufacturing capacity and ASP reductions for consumer electronics.