- Silicon chip wafer-maker cautions of slower-than-expected second-half recovery
- Semiconductor makers already carrying lofty inventory worldwide
- ARM deal getting ready to price even as industry outlook remains uncertain
- Chip stocks have a good record as a proxy for global stock markets
“The good news is that IQE is not issuing a third profit warning this year, after those of January and March, but the bad is that the hoped-for recovery in the second half of the year is developing more slowly that the specialist silicon chip wafer-maker would like,” says AJ Bell investment director Russ Mould.
“A second profit warning in three months means shares in silicon chip wafer-maker IQE are taking another hammering, but the latest earnings setback could also have wider implications for the global economy and financial markets. This could have implications for the ARM initial public offering, or at least the after-market once the float takes place, and the wider semiconductor industry, which is a fair proxy for worldwide economic activity and a useful measure for stock markets’ risk appetite.
“IQE has previously cautioned about an inventory pile-up through the semiconductor industry food chain but added that it expected an improvement in demand in the second half of 2023.
“However, the statement alongside the first-half results talks of how the current semiconductor industry downturn is ‘stabilising’ and that buyers are coming back more slowly than expected, and only from certain industries and not others.
“IQE still believes that sales in its second half will grow at a ‘double digit’ percentage rate from the £52 million generated in the first six months of the year, but that suggests the current analysts’ consensus forecast of £124 million for the full year is a bit of a stretch. This does imply a second-half figure of £72 million, a sequential improvement of nearly 40%, and the statement just does not read that positively.
“The Welsh firm also noted that adjusted earnings before interest, taxes, depreciation and amortisation (or adjusted EBITDA) should be a positive figure for the whole of 2023 after the first half’s £5 million deficit, but this is no better than expected, given the current consensus forecast of £6 million for the year.
Source: Company accounts, Marketscreener, consensus analysts’ forecasts
“The slowdown in demand is the combination of cooler end markets – notably for smartphones and servers for cloud computing. It is also probably the result of original equipment manufacturers (OEMs) double-ordering to try and bag what they needed when supply chains were fractured and demand was seemingly running away during lockdowns, as consumers found themselves stuck at home with stimulus money burning a hole in their pockets. Now those gadgets have been bought, people have gone back to work, and inflation has eaten into savings and disposable income alike, while supply has caught up. As a result, OEMs may not need all of the silicon chips they ordered, and unwanted product has backed up at the chip makers themselves.
“According to industry specialists such as WSTS, SIA and Gartner, global silicon chip sales will drop by some 10-12% in 2023 although they are forecast to rebound by a similar degree in 2024, a view which no doubt underpins IQE’s repetition of its forecast that 2024 will be a better year.
Source: WSTS, SIA, Gartner, Statista
“The good news is that the true giants of the silicon chip industry – the members of the 30-strong Philadelphia Semiconductor Index, or the SOX – showed a 6% quarter-on-quarter increase in their aggregate sales between April and June, to end a run of two straight decreases. This fits with IQE’s scenario of a stabilisation in demand, even if total sales of $113 billion across the 30 firms still meant a 5% year-on-year decline and left revenues no higher than they were in Q4 2021.
Source: Company accounts
“However, the hoped-for second-half recovery rests, at least partially upon the assumption that the industry-wide inventory bulge will come under control quite quickly. A study of the balance sheets of the 30 companies which make up the Philadelphia Semiconductor index, or SOX, suggests there is the supply chain is still backed up and clogged up with unsold product somewhere along the line. Granted, inventory has stopped surging, but it still rose by $500 million in the second quarter in aggregate across the 30 SOX stocks, to leave the total 21% higher year-on-year, a figure which does not sit easily with April-to-June’s 5% year-on-year revenue decline.
Source: Company accounts
“At least total inventory days fell to 144 days in Q2 from 145 in Q1, but chip firms still have a lot of inventory to work down before they can crank up production and boost both overhead recovery and margins once more.
Source: Company accounts
“Unless these inventories are worked down quickly – and that needs strong demand from key markets like wireless devices, computing, consumer electronics, automotive, telecoms networks and industrial robotics, then even hopes – or forecasts – of a second-half recovery could prove optimistic. The sequential increase in aggregate SOX index net income for Q2 came from just two of its 30 members, Intel and NVIDIA. The former stopped writing down assets, the latter showed a huge boom in sales and profits, although even in the case of NVIDIA there are questions to be asked about the balance sheet. The issue here is not inventory, but trade receivables.
“Trade receivables surged 73% quarter-on-quarter and 33% year-on-year, eye-catching figures even as sales rose 88% quarter-on-quarter and doubled year-on-year.
Source: Company accounts
“This suggests that either NVIDIA shipped an awful lot of graphics chipsets right at the very end of the quarter (and thus did not have time to collect cash payment) or it booked revenue up front and aggressively recognised revenue on longer-term software or data centre service revenues, again without receiving the cash.
“None of this illegal and all of it is open to interpretation (hence the old saying that profit is a matter of opinion and cash is a matter of fact). But it does feel as if NVIDIA is pulling forward revenue from long-term deals, although why it should feel the need to do so, other than to perhaps reinforce its credentials as an AI leader, can only be a matter of conjecture.
“Either way, inventory bulges and a surge in trade receivables at the firm that is doing more than any other to keep investors interested in silicon chip stocks and the SOX have potential implications for both the ARM flotation and equity markets more widely.
“The 28-strong banking syndicate is closing the books early on the ARM deal, to suggest the combination of cornerstone investment from leading technology firms and appetite from institutional investors is providing more than enough demand for the 10% stake being sold by Softbank to justify the $47-51 a share price range and the implied valuation for the equity.
“However, a lot of IPOs in 2020-22 went up like a rocket and came down like a stick, especially when the free float was limited and prey to initial squeezes.
“If IQE’s wary outlook statement alongside its interims is any guide, there is still work to be done, if the SOX index is to justify 2023’s 40% gallop and then keep going.
“Any signs of weakness in the SOX could be a concern. History is by no means guaranteed to repeat itself, but the SOX topped out six to nine months before the S&P 500 and FTSE All-World did so in 2000 and 2007, to herald two thumping bear markets, and then bottomed out before those headline indices did in 2002 and 2009, to signal the start of a new bull market.
“Equally, the SOX almost halved from peak to trough in 2022 and that may have gone a long way to pricing in a lot of bad news in 2023, and if the index does keep on going higher than the widely anticipated global recession could still be further away than many expect.
Source: Refinitiv data
“IQE is not immune to these global trends in the chip market, even if it tends to march to its own beat.
“This is partly because it does not make chips, but the wafers from which they are made.
“And it is partly because it does not provide traditional, pure silicon wafers. Instead, IQE makes wafers from more complex compounds, such as Gallium Nitride (GaN), Gallium Arsenide (GaAs) and Indium Phosphide (InP).
“These so-called epitaxial wafers are then used as the basis for chips that are used in specialist functions and products, such as mobile handsets, mobile telecom network infrastructure, 3D imaging and sensing and photonics systems for fibre-optic telecoms networks.
“These target markets enjoy demand cycles all of their own, which are as much led by technology and the shift to next-generation products as the wider economic cycle. This is a little different from the broader silicon chip industry, which follows a more typical boom-and-bust pattern, related to swings in demand caused by the economic cycle and swings in supply as manufacturers cut or increase investment according to where they think demand is going next.
“However, IQE’s chart now looks like that 2020-21 boom never happened and it will be interesting to see if that is a wider message for the economy more generally as 2024 develops.”
Source: Refinitiv data
