The variables that lead us into the global economic recession were complex. Equally complex were the US fiscal and monetary policies that allowed for the 2009 'green shoots' to emerge and take root. For the semiconductor and electronics industries, these policies, coupled with the aggressive supply chain management practices, have pushed present earnings to beat expectations and increased the bullish forecasts for the remainder of 2010 and through 2011.
There are many opinions about the American Recovery and Reinvestment Act of 2009 (ARRA), and many verdicts yet to come, but one sentiment echoes among financial and economic analysts: "[…] aggressive monetary and fiscal policy actions are at the heart of the recovery of economic activity and the strong improvement in corporate profitability in the United States." (Credit Suisse, US Equity Strategy, 4/16/10, p.1)
Today's macro-economic questions center around: What is this new economic cycle? What shaped curves will we follow? And, can the rebound maintain enough forward momentum to preclude a double dip recession? Our industry relevant answers are rooted in the present trajectories from the second quarter of 2010 (2Q10) through 2011 and the changes in economic behaviors by consumers and corporations alike.
What went right: An overview of the Americas 2009-1Q10
The United States
Eighteen months ago there was global concern about the future of our industry: who would be left standing and what type of future our industries would have. By this time last year, the famous 'green shoots' in the US economy were the main story, and rightly so. As Credit Suisse analysts summarize (US Equity Strategy, 4/16/10, pp. 4-6), the aggressive policy actions by the US government were critical to enable corporate profitability. It is this corporate profitability which grew over the past year that is the solid foundation supporting the forecasted growth and profitability for semi and electronics throughout 2010-2011.
What went right? As summarized by the same Credit Suisse report, the US policies that supported and nurtured last Spring's 'green shoots' included:
- A 'close to zero' funding rate for large financial institutions
- Very rapid growth in the money supply (i.e., "broad money")
- A $1,500 billion expansion of the securities owned by the Federal Reserve
- A sharp decline in effective tax rates
- A rapid expansion of government spending
[…] This combination of activities elevated financial asset prices and increased after tax incomes and facilitated transactions and nurtured financial sector profitability all at the same time. Together, all these initiatives clearly worked some macroeconomic magic. (CS, 4/16/10, p.4)
The situation in Latin America (LATAM) has been different than its northern neighbors because these geo-economies are primarily emergent and fared differently during the global economic recession. For semi and electronics, the most dramatic changes were seen in those geo-economic regions with core manufacturing, design, consumption, and/or heavy merger and acquisition or consolidation activity. Measures to control inflationary pressures (i.e., rate hikes and tightening monetary policies; responding to food inflation; etc.) in LATAM are seen to be the more pressing issue on the near horizon (2Q10) and are forecasted to trickle through the region's economies stepwise (cf. Citigroup Global Markets, 3/24/10, Latin America Macro and Strategy Outlook, pp. 4-11). Consumer and corporate demand (particularly in Brazil) continue to be following emergent economy patterns and showing growth in the region, as has been the news for a few cycles now, and these trajectories are expected to continue.
Two other countries' economies of particular note are Chile and Mexico. Chile's trajectory will continue to be tempered by the recent and devastating earthquake that is affecting all sectors of the economic activity, though overall growth is not seen to be greatly impacted (ibid., Citigroup, p. 34).
Mexico is a positive story, with a continued strong GDP growth rate of 3.8% year-over-year (YoY) for 1Q10. This growth is due to strong exports of automotive, electronics and electric components. More specifically, these markets are showing particularly good industrial production numbers with increased market share across the board. "The US$333 million January trade deficit was rather small: this is consistent with the sector [electronic components] leading in the recessions (that is, export-related manufacturers) being also the sector leading in the recovery." (ibid, Citigroup, p.42) In short, Mexico's good economic position presently is, like the US, also being supported by the strength and positive movement of the electronics industry, among other critical economic and political variables.
Looking farther north, Canada's real GDP is forecasted to be at 3.2% YoY (close to the US, at 3.3%), and supported by steady consumer spending, seen to be building back into the 2.5% range for the estimated year 2010 (Y10E) (cf. UBS Investment Research Canadian Watch List, 4/16/10, pp.12-13). Canada weathered the global recession relatively well for a developed geo-economy and that good standing will continue to provide a cushion going forward.
1Q10: The trends that are supporting strong reports
The variables that lead us into the global economic recession were complex. Likewise, the various governments' policies that moved us out of recession and onto the present recovery path were equally complex and varied. For the semiconductor and electronics industries, these policies, coupled with the aggressive supply chain management practices, have pushed present earnings to beat expectations and increased the bullish forecasts for the remainder of 2010 and through 2011.
The story of 1Q10 itself is not as complex; it is actually quite elegant. It is this simplicity, with solid continued pent-up demand, that gives such strong support to the positive reports and numbers:
- Macro-economic forecasts for the US show gross GDP growth at roughly a 2.3% quarter-on-quarter (QoQ) level for 1H10 (cf. OECD, 4/7/10, "What is the economic outlook for OECD countries? An interim assessment" p.4 )
- US fiscal and monetary policies are seen to be functioning well through Y10E (though changes to come in 2011 when dismantling is set to take place)
- The move from demand-sparse to supply-sparse trends
Having explored the macro-economic environment briefly for the region, we now turn our attention to the semiconductor and electronics supply chain. The industry focus will allow us to understand where the support for the bullish semi and electronics forecasts is coming from, and what their longevity and sector reach may be. Specifically, we will explore point three above.
The demand-sparse conditions we left behind were rooted in low corporate and consumer confidence leading to decreased spending on electronics products and components during the past 12-18 months. During that time, strict inventory management along the supply chain successfully reduced supply and flushed the system of most excess, protecting ASPs and margins as best as possible.
Regionally, geographic analyses for February 2010 show that the "Americas accounted for 16.9% of overall revenues," behind only the Asia-Pacific (APac) region (52.9% of overall revenues). Furthermore, based on the WSTS data, "m/m [month-on-month] revenue growth was above seasonal […]" (Credit Suisse, Semiconductors 4/5/10, "February 2010 SIA Data" p.7). These data reveal that 2010 has been underestimated and that above seasonal growth we are presently experiencing is implied going forward through 2H10.
Analysts posit, and Smith's data underscore, that Y10E forecasts are indeed underestimated. Aggregate and individual component data reveal that trends are still below seasonality on specific bellwether components, particularly IC unit shipments (not including memory). This view is echoed by Credit Suisse: "We remain positive on the semi cycle, and believe semis are on track to grow 25% in 2010 (Street est[imate]s ~21%) with upside driven by pricing and supply chain inventory restocking; normal seasonal m/m [month-on-month] growth from Feb levels would imply 2010 rev[enue] growth of 26.7% y/y [year-on-year]." (ibid p.1, ff)
Tight supply is the core variable at play throughout the supply chain. With utilization rates running between 80-98%, there is little room for increased production. Book-to-bill ratios remain very strong and show no signs of abating, further underscoring strong demand in the face of tight supply. With CAPEX spends having been dramatically reduced since 2007, and new spends being dedicated to newer, smaller architectures, there is little reprieve seen for the present shortages. As such, the forecasts from both analysts and those along the supply chain see a tight supply chain for the remainder of Y10. These component shortages and the "lack of supply growth will provide a stronger upturn than expected." (Credit Suisse, Semiconductors 3/23/10, "The 2H Bull is the Black Swan" p.1, ff)
Already the effects of these supply shortages in the supply chain are being seen, for example, ASPs have been rising, particularly for memory. The reason for the memory spikes go directly to the heart of the demand variables. 1Q10 and the estimated 2Q10 (2Q10E) growth is being driven by consumer demand for rather specific electronic products. Namely, netbooks, increased memory for Microsoft Windows 7, smartphones, and touchscreen devices with higher memory requirements have been in particular demand by consumers.
It is the pent-up demand in the corporate sector that most strongly resonates across analysts and industry reports. The corporate sector demand is rooted in PC replacement cycles, increased memory to support Microsoft's Windows 7, server upgrades, SSD, and networking equipment upgrades/replacements. We have yet to see the cash rich corporate sector engage in the amount of fixed CAPEX business investment that we know is coming. Cyclicity shows that these purchases were postponed due to the global economic recession in order to safeguard cash. As a result, this pent-up corporate demand means that additional growth is to come in 2H10 and that the rebound experienced presently has legs – it is not based on wishful thinking (cf. Citigroup Global Markets 2010 Supply Chain Playbook and 1Q Preview 4/13/10; . Credit Suisse, Semiconductors 4/5/10, "February 2010 SIA Data"; Credit Suisse, Semiconductors 3/23/10, "The 2H Bull is the Black Swan"; and OECD, 4/7/10, "What is the economic outlook for OECD countries? An interim assessment" p.4; to name a few).
There is one more variable to consider from within the supply chain itself. This variable is part of a model by Citigroup Global Markets who posit that there is a four-phase EMS economic cycle in the semiconductor industry. According to Citigroup analysts, the industry has reached the third of the four phases meaning that fundamentals will now stabilize:
Going forward, we expect organic revenue trends to stabilize and begin following more normal seasonal trends, OEM restructuring activities to lead to incremental outsourcing opportunities, and recent restructuring initiatives to lead to margin expansion across the industry. […]
Importantly, we expect EMS fundamentals to bottom and begin improving during this phase as modest levels of incremental outsourcing and asset purchases should bring revenue stability back to the industry. This, combined with recent restructuring efforts, should also lead to profit stability and/or improvement. (Citigroup Global Markets 2010 Supply Chain Playbook and 1Q Preview 4/13/10, p.5)
2010-2011: The new economic behavior of consumers and corporations
Among the new trends recently, is the change in consumer and corporate economic behavior. More specifically, consumers in the US, in particular, have faced some of the most severe personal economic and employment conditions since World War II. Yet, while curtailing discretionary spending on leisure, travel and dining, these consumers have increased their electronics spending, particularly for netbooks and smartphones, followed by other consumer electronics for home and/or personal entertainment. These trends are seen to continue through 2H10.
Furthermore, the cash rich corporate sector is maintaining high levels of business confidence (cf. Credit Suisse US Economics Digest 4/13/10, Business Capex: Motive, Opportunity, Means, pp. 1-5). As discussed above, corporations are exiting very conservative CAPEX spend patterns and now facing replacement cycles for hardware (and software). Credit Suisse forecasts roughly 9% increase in business investment in equipment and software during 2010 (Q4/Q4) (ibid, p.5). Because these expenditures have not surfaced yet in the industry data, they are forecasted to hit during 2H10. With supply tight, this added corporate demand will provide
Many investment projects were postponed during the recession – so much so that on a net basis, the business sector effectively de-capitalized itself. This was another manifestation of the urge to conserve or raise cash that saw inventories liquidated and payrolls slashed. As the urgency to build cash is relieved, that is, as large corporations' balance sheets are fortified, last year's physical de-capitalization should turn into re-capitalization. (ibid, p.2)
In sum, there were many things 'done right' during 2009 by both governments and by the semiconductor and electronics supply chain that fostered early 'green shoots' and then allowed for healthy growth to take root and leave us in a very bullish position presently for the industry in the region. The complementary CAPEX reductions coupled with rather draconian utilization rate cuts by fabs were critical to preserve liquidity, immediately restrain the inventory in the supply chain, and then help to reduce the critical days of inventory (DOI) levels throughout the supply chain. These well-checked DOI levels protected ASPs as best as possible and allowed those along the supply chain a chance to weather the economic storm. While not all did survive, the inventory controls were critical to those who did.
Now these well managed supply chains are also the strength of the recovery and the continued source of bullish forecasts as demand-sparse cycles have been replaced with supply-sparse conditions and ASPs are rising. The forecast for 2H10 and through early Y11E is very positive for our industries across market sectors thanks to improved confidence across the board coupled with corporate pent-up demand.