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This Time, Inventory Buildup Is a Positive

Six months ago, the electronics industry viewed a buildup in semiconductor inventory with concern. This week, an increase in semiconductor stockpiles is a welcome relief.

The difference, analysts say, is the reason for the buildup: IHS iSuppli reports that chip stocks are being increased in anticipation of demand.

Sharon Stiefel, a semiconductor inventory analyst at IHS, offered an explanation in a press release on the report:

In the fourth quarter, inventory rose among suppliers because of uncertain macroeconomic conditions such as the sovereign debt crisis in Europe, leading to an overall decline in the worldwide demand for semiconductors. And while inventory rose during the fourth quarter for semiconductor suppliers, chip stockpiles fell at the same time among customers, indicating a paucity in demand. In contrast, the higher inventory numbers among semiconductor suppliers for the first quarter of 2012 represent a signal of better things to come. There was an increasing level of inventory both among chip suppliers and customers, indicating that both the supply and demand sides of the business believe that the environment in the electronics market has turned positive.

The report is the first real evidence that the market is turning around. During their most recent quarterly conference calls with analysts, executives at the industry's two largest distributors, {complink 453|Arrow Electronics Inc.} and {complink 577|Avnet Inc.}, said they believed the industry slowdown had bottomed out. The book-to-bill ratio, which measures the balance of supply and demand in the channel, was approaching or had reached parity in all geographic regions in the first quarter. A ratio higher than 1:1 indicates growth in demand.

Inventory decreased steadily at the end of last year. Distribution inventory fell from 41.7 percent of revenue in the third quarter to 36.9 percent in the fourth quarter, IHS reports. The same pattern was replicated in various customer segments. Distribution inventory fell from 26.7 percent to 24.9 percent for EMS providers, from 21.5 percent to 20.8 percent for OEMs in the storage segment, and from 13.8 percent to 9.6 percent for handset makers. This data, combined with anticipated higher demand in the second quarter, led chipmakers to increase supply, according to IHS.

There are still reasons for concern. Chipmakers typically ramp up too much capacity when demand returns, leading to an oversupply. IHS warns:

Memory companies, in particular, are historically prone to larger swings in oversupply and undersupply in response to shifting end demand, making them potentially vulnerable.
The analog semiconductor segment is another potential problem area, because the sector is exposed to markets — such as industrial communications infrastructure — that are traditionally slower to rebound from cyclical downturns.
Nonetheless, as overall semiconductor sales increase over the course of this year, the ratio of inventory to sales increasingly should come into alignment. The anticipated return to moderate demand will also give semiconductor suppliers an extra dose of confidence in knowing that their inventory levels are appropriate.

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