Although the global chip market looks like it might shrink next year, local players remain upbeat. However, this sector has become increasingly entwined with politics, adding an extra dimension to consider for investors.
Before Europe became embroiled in its largest conflict since 1945 and inflation started to dominate headlines, the world was worried about cars sitting unfinished on factory floors and consumer electronics facing delays, all due to a shortage of semiconductor chips.
The semiconductor industry had hogged the limelight for most of 2020 and 2021 as demand for electronics during the pandemic surged, spurred by remote work arrangements and stimulus packages, sending orders for laptops, tablets and other electronic devices soaring and putting pressure on supply chains already affected by the pandemic.
Separately, carmakers were forced to cut back on production when chipmakers could not meet demand as most of the capacity had already been set aside for earlier clients. To cope with the demand surge, foundries like Taiwan Semiconductor Manufacturing Co (TSMC), Samsung Electronics and Intel Corp have committed to massive capacity expansions. But as these expansion projects take time to come on stream, market dynamics have continued to favour the sellers.
Yet, two years into the shortage, these expansions might end up being the same reason tipping the semiconductor market into a downturn when supply outstrips demand.
Already, there are reports of chip demand easing. In his Aug 3 report, S&P Global Ratings analyst David Hsu did not mince his words: The global foundry industry’s balloon is about to deflate. “Given capacity expansions in the recent upcycle and inventory stockpiling to avoid another round of Covid-19-related disruptions, downside risks abound.”
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Hsu expects the industry to experience a cash crunch as chip companies take on larger- than-usual borrowings to fuel the expansion.
“We view the volatile macro movements, capacity additions and inventory behaviour as the key swing factors for the foundry industry.”
At the other end of the supply-demand scale, end-demand weakness in consumer electronics could gradually feed through to semiconductors. The balance will be tipped further by capacity additions and Covid-related changes to inventory behaviour, like stockpiling, which amplifies the downturn.
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According to the Semiconductor Industry Association, world chip sales, while still growing, has slowed for six straight months — the longest streak since the trade war between the US and China broke out in 2018. In June, the most recent monthly update, sales were up 13.3% y-o-y but down from 18% y-o-y recorded in May, which is “yet another sign the global economy is straining under the weight of rising interest rates and mounting geopolitical risks”.
Gartner, another tech research firm, on July 22 nearly halved its 2022 sales growth estimate to 7.4%, versus growth of 26.3% recorded for 2021. This coming year will see the market shrink by 2.5% to US$623.1 billion ($855.45 billion).
The drag is likely to come from consumer electronics end-markets, namely PCs and smartphones. “Rising inflation, taxes and interest rates, together with higher energy and fuel costs, are putting pressure on consumers’ disposable income,” says Gartner analyst Richard Gordon.
The slowdown was in contrast to some of the bullish views by some analysts earlier this year that the shortage will not be resolved by the end of 2022 or even through to 2023.
Others, like Phelix Lee of Morningstar, seem to be more accurate in their prediction, in hindsight. He told The Edge Singapore in April that the shortage will only ease in the second half of 2022 after carmakers resolve their shortage. He also predicted that prices will moderate in 2023 while 2024 might see an oversupply situation.
High-end, low-end
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The chip industry is a complex one, with multiple product segments having their own specific market dynamics at different points in time. In short, not all chips are created equal.
Speaking to The Edge Singapore, Nina Turner, research manager for IDC’s enabling technologies and semiconductor team, says that the shortage is being resolved but at a different pace across different end-markets.
The so-called “leading-edge” chips — those used in laptops and smartphones where there is non-stop competition for efficient computing power — have largely resolved their shortages. Older chips, such as those used in the automotive and industrial sectors, are still facing shortages, as factories producing these older-generation chips are fully depreciated so “no one is going to invest in building up new inventory. There’s less capacity expansion in those older process nodes but there’s a lot of products that are still run [on these nodes],” she explains.
Turner says the only exception is China, which has spare capacity to make the older-generation chips because as chipmakers upgrade their lines, older equipment is sold largely to China.
On Aug 5, Micron Technology, which focuses on memory chips, warned that its fourth-quarter revenue will not meet projections as demand for consumer electronics such as notebooks and smartphones soften. There will be “significant sequential declines in revenue and margins”, says Micron in a regulatory filing — a stark change from its guidance just a month ago.
Micron is not alone. Nvidia, famous for its graphics processors, and Intel, the leading name in this industry, have similarly flagged near-term pressures. Reasons generally cited include slowing demand for the devices, and consumers becoming more careful with their purchases as inflation eats away at their spending power.
Separately, Counterpoint Research notes that the production of chips used in premium and mid-tier 5G devices, made by the likes of Qualcomm and Samsung Electronics, have also outstripped demand.
In contrast, chips used in vehicles, made by the likes of NXP Semiconductors, Infineon Technologies and Texas Instruments, are still recovering from Covid-driven shortages. US carmaker General Motors expects its second-quarter results ending June to take a hit due to issues with certain components.
Turner sees the shortage in the car industry easing by the third or fourth quarter of 2022. By then, the supply-demand balance might quickly tip over, due to excess inventory as well as production in the growing pipeline, sending the chip industry into a downturn.
Brace for impact?
The worries over this potential excessive capacity might come as a surprise to casual observers of the industry. The past year or so has been marked by regular announcements by chipmakers spending eight-digit figures to ramp up capacity.
Singapore, which already has a sizeable chip-making presence, might draw market leader TSMC to set up shop here, according to a Wall Street Journal report in May. TSMC, which did not confirm the plans, reportedly said it will spend between US$40 billion and US$44 billion in 2022, almost half of the US$100 billion capital expenditure committed between 2021 and 2023.
Last November, Samsung Electronics announced plans to build a US$17 billion plant in Texas. In July, Chey Tae-won, chair of SK Group, the parent of South Korean semiconductor company SK Hynix, held a virtual meeting with US President Joe Biden to announce US$22 billion worth of investments in semiconductor, electric vehicle battery and green technology in the US.
However, being a complex system, a chip manufacturing facility needs anywhere from 18 months to a few years, depending on its size and complexity, to start commercial production. But this pandemic-induced shortage is being resolved even as new committed capacity comes online.
Will the new supply lead to a capacity glut then? Turner says that this may not be so, as companies have long-term supply agreements with some of their customers, and chipmakers can slow the pace of their expansions by holding back the delivery of new equipment.
However, the global supply-demand imbalance might get more complicated because of the trend of “reshoring”, where new capacity in the US, for example, is required to be put to work as part of the US government’s support for the industry.
Turner explains: “[Companies] are going to be looking at the trade-offs between their investments and the money that they can get from the different governments, and if they slow it down, do they lose out to somebody else?”
She says much depends on how government subsidies are structured. If it is first come, first served, then there might not be a slowdown in the investment or capital investments.
In that case, Turner thinks that there will be overcapacity, but she is also certain that companies will watch the market and their order visibility lest they get caught with massive overcapacity. The likes of chipmakers such as Micron are reportedly following Intel in reducing capex “meaningfully” this year versus 2021.
On the other hand, she believes the foundries will continue to do well, with revenue growth of 31% this year over 2021. Part of that growth comes from higher prices required to cover inflation. “They may get more revenue, but I don’t know if their gross margin will decrease because of those [raw material] inputs,” says Turner.
But not all chipmakers will see similar declines. Those with a wider product range will show greater resilience. For example, Globalfoundries, which announced plans for a US$4 billion plant in Singapore last year, gave a more bullish outlook after reporting sales and profit that topped estimates. Revenue in its most recent quarter was US$1.99 billion, slightly above estimates.
As for “fabless” companies like Advanced Micro Devices (AMD) and Nvidia, which outsource their production to foundries, Turner thinks they are in a better position as they incur lower capex. However, these foundries will be more vulnerable to capacity constraints if demand starts to ramp up, as they are busy fulfilling someone else’s orders.
While the headline numbers point to a slowdown this year and then a drop next year, the actual picture differs. “Who’s going to be hit the hardest? It is dependent on [their] end-market,” says Turner.
For example, chips used in smartphones might see softer overall sales but new handset models are in the market more frequently. Carmakers might demand more chips now but the product cycles of cars are longer.
All chips begin as part of a silicon wafer, but command different prices due to differing demand for different end-markets.
To misquote George Orwell’s Animal Farm, all chips are equal, but some are more equal than others.
