Recession may have slammed the brakes on the digital revolution, but the latest semiconductor-industry figures suggest a technological revival is already taking place. According to the Semiconductor Industry Association (SIA), there was a jaw-dropping 56 per cent year-on-year sales rise in February to $22bn. Semiconductor sales for the latest PCs and mobile phones are predicted to jump 10 per cent and 17 per cent respectively in 2010, says the SIA, with consumers clamouring for flashy smart phones, and Apple’s latest iconic gizmo, the iPad.
More than 500,000 iPad tablets were snapped up in the first week of US sales, about 25 per cent more than the most optimistic predictions. Demand was so great that it has forced the company to slam the brakes on its planned global launch due to stock shortages. Consumers outside the US, including Brits, will now have to wait until the end of May to get their hands on an iPad.
Remaining at the cutting edge of technological developments is as vital for the semiconductor industry’s success as it is for Apple’s. Even with forecasts of strong volume growth, the industry faces an inevitable drop in selling prices as new chips become standard and commoditised. Just as the price of PCs, DVD players and digital cameras falls rapidly in the shops, so there is continual pressure on suppliers to cut prices, too.
Bellwether points the way
For investors, timing is the key to this cyclical market and optimism currently holds sway, especially in the wake of record first-quarter revenues reported by US chip giant Intel last week. Intel is a bellwether of the global semiconductor industry. It posted an astonishing 44 per cent hike in Q1 revenues to $10.3bn, about $500m above market forecasts. Such an impressive performance owes much to sales of Intel’s new mobile processors, including its i7 quad-core chips.
Signs are encouraging within its core PC market as well. Corporations may have cut their spending to the bone in order to survive the past two years, but, ultimately, they have to invest if they want growth. Since many corporate computers are, on average, three to five years old (virtual dinosaurs in the fast-moving world of PCs), they start to cost more to keep than to replace. There comes a time when the only solution is to buy new ones. Bolstered by the successful release of Microsoft’s Windows 7, plus new product launches from server and PC manufacturers, the need for PC upgrades has recently become more pressing, and Intel sees signs of “a return to corporate demand”.
Concern over energy efficiency is fast becoming a new driver for the semiconductor industry, too. Fifty years ago, if power ran out, companies would simply build another plant. Now they raise prices, which means slashing energy consumption is vital to cutting costs. That’s good news for companies making more efficient electronics, and for the long-term future of the semiconductor industry.
Intel tends to report its financial results quicker than most of its peers, so its numbers bode well for the raft of Q1 trading updates from the industry scheduled for the end of April and early May – including ARM (29 April), plus Wolfson Microelectronics and blue-tooth chip maker CSR (both 5 May). Market researchers IDC and Gartner recently upped IT spending growth estimates for 2010 to 3 per cent and 4.6 per cent respectively, while Gartner recently predicted 20 per cent growth in global semiconductor revenue this year to $276m.
KPMG’s annual survey of semiconductor executives also paints an upbeat picture of the industry. According to its study, more than half of all respondents (54 per cent) expect revenue growth of 10 per cent or more during 2010, with 18 per cent eyeing 20 per cent-plus. “After a year-long global slump, demand for silicon chips and semiconductors is rebounding due to increased demand for wireless and consumer electronics,” says the survey’s author, Ron Steger, partner in charge at KPMG’s global semiconductor practice.
Gremlins in the machine
However, there are dissenters amid this crowing chip-making fraternity. Broker Liberum Capital reckons that signs of weakening demand are already all too obvious, arguing that netbook/laptop sales have been weakening, sales of LCD TVs over the Chinese New Year were disappointing, and that cars sales in Europe are wobbling as the scrappage schemes run out of fuel. According to Liberum, German vehicle registrations were down 20 per cent year-on-year in February and March.
“We believe the recent strength in semiconductor orders has been on the back of double ordering and inventory building across the supply chain,” warns Janardan Menon, industry analyst at Liberum. “This is likely to put pressure on share prices.” This view appears to be supported by VLSI Research, a consultancy owned by US tech giant Oracle, whose recent industry study suggested that February inventories jumped 46 per cent year-on-year and are close to the record levels of October 2008. “The sector is overheating in our view,” insists Mr Menon.
The technology hardware sector, within which the semiconductor companies reside, has beaten the wider market considerably during the past three years, rising in value by one-third compared with the 12 per cent slump in the FTSE All-Share index. More recently, over the past three and six-month periods, technology hardware has outperformed the All-Share index by about 6 per cent and 9 per cent respectively.
ARMAlarming valuation
ARM is a good case in point. It has a long pedigree designing cutting-edge microprocessors and the shares have exploded into life, soaring from a low of 104p within the past year to about 235p at the time of writing. Yet Liberum’s Mr Menon worries about lost market share to Intel in the hot smart-phone market and potential inventory corrections that could undermine ARM’s royalty rates. On an implied 2010 PE ratio of 35, it is not difficult to see why a slew of brokers, including RBS, Citigroup, UBS and Deutsche Bank, have downgraded their recommendations on the shares simply because the price has run ahead of itself.
Edinburgh-based Wolfson Microelectronics is an interesting recovery play. Its failure to produce goods on time meant Apple dumped the company in 2009, sparking a raft of profit warnings. However, chief executive Mike Hickey has shifted the company to long life-cycle products rather than high-cost launch versions, a move that has helped slash costs and double output. If it can convince the market that design wins can be retained, the shares could sparkle once more.
ARM licenses its designs to manufacturers and receives royalties on each chip, as well as one-off licence fees. It even pays dividends. Yet, there are question marks over its ability to fend off competition from Intel, particularly in the smart phone arena. While Q1 figures are likely to be strong, and investors must pay for true quality, having more than doubled in a year to trade on a forecast 2010 PE ratio of 35, the shares are too pricey.

Undercover Columnist says:

The semiconductor industry remains tied to the continual renewal of consumer electronics and, to a lesser extent, global car sales and renewables. But this is a highly-cyclical market and an early responder to economic recovery, too. This explains the impressive share price performances in recent months and more of the same looks likely throughout the rest of the year for the best companies with the most exciting technologies. However, overall we are neutral on the sector.
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