【TEJ Finance Research Institute】 Dramatic Surge in Inventory: The Dark Clouds Gathering Over the Semiconductor Industry
Semiconductor industry struggles with sluggish inventory turnover, short-term demand upsurge remains elusive.
Preface
Since 2022, the world has entered the post-pandemic era. The capacity bottleneck in semiconductor foundries has finally been resolved. However, as the demand gap left by the PC industry has shifted towards high-performance computing, 5G, automotive electronics, and the IoT, the overall semiconductor industry still showcased a impressive revenue in the first three quarters of 2022. Moreover, with the average selling price (ASP) of logic IC products on the rise, the industry enjoyed unparalleled profitability, reaching a staggering 1.33 trillion dollars, with 47% YoY. Notably, TSMC (2330. TW) played a vital role in this success story.
Nevertheless, the memory semiconductor industry faced headwinds with excess capacity, repeated downstream orders, and weakening end-user demand. These factors led to a downturn in the industry, resulting in lower ASP for memory products, ultimately affecting both revenue and profitability. Furthermore, the aforementioned challenges were not confined to the memory industry but also extended to non-memory semiconductor sectors as well. In other words, the overall semiconductor industry has transitioned from the “inventory super cycle” phase to an “inventory adjustment period”.
Keywords: Semiconductor, Inventory, Industry Analysis, Trade War
Guidance:
📍Record-High Inventory Levels and Days of Turnover
📍Escalating Inventory Levels
🔹Definition of Indicators of Inventory Level
🔹Result
📍Conclusion
Record-High Inventory Levels and Days of Turnover
The semiconductor industry witnessed a significant surge in overall inventory levels, reaching a 7.75 trillion dollars by the end of the third quarter of 2022 (see Figure 1), marking an 82% YoY increase. This indicates that the inventory levels at the end of the third quarter surpassed the levels caused by panic buying and repeated ordering from the previous year. In other words, the accumulated inventory from last year’s repeated orders has not been fully consumed, and it has been compounded by new inventory generated from fresh demand. Among these, the IC design industry experienced a dramatic increase in inventory, with a 138% YoY growth, amounting to 2.65 trillion dollars (34% of overall inventory). Following closely behind is the semiconductor foundry industry, which saw an 84% YoY increase, reaching 2.67 trillion dollars (also 34% of overall inventory).
As for inventory turnover days, the semiconductor industry experienced an overall extension to 96 days for the first three quarters of 2022, reflecting a 25-day YoY increase. This can be interpreted as a sign of a sluggish end-market, reducing the overall shipping momentum of the semiconductor industry. Among different sectors, the memory manufacturing industry recorded the highest extension in turnover days, with 173 days (69-day YoY increase). The second goes to IC design industry, with 137 days (a 40-day YoY increase).
Note: Inventory turnover days are calculated as 365 divided by (annualized cost of goods sold / ending inventory).
Escalating Inventory Levels
Definition of Indicators of Inventory Level
Because of fluctuating raw material prices (especially with the influx of capital in 2021 and the outbreak of the Ukraine-Russia conflict at the beginning of 2022) and severe supply-demand imbalances, defining inventory levels based solely on the amount of inventory is inadequate. Irrational pricing behaviors, such as excessive price hikes or cuts, also contribute to the inventory level. Therefore, to eliminate the influence of price factors, the concept of inventory level is defined by adjusting the inventory amount using the cost of goods sold, thus deriving the term “inventory level.”
Next, we observe the changes in inventory levels for each quarter from 2017 to the end of the third quarter of 2022. Additionally, within this observation period, several significant events occurred, and the average inventory level during each specific event period is considered as an observational indicator. The major events are listed as follows:
- Trade War (June 2018 to December 2020)
- Huawei Ban (May 2019 to September 2020)
- Supply Chain Disruption Due to COVID-19 Lockdown (January 2020 to June 2020)
- Business Opportunities of Remote Work (July 2020 to December 2021)
- Capacity Bottleneck in Semiconductor Foundries (January 2021 to December 2021)
Results
The semiconductor industry experienced its first peak in overall inventory levels around mid-2018 (see Figure 2). This was driven by the release of capacity by Chinese manufacturers (including SMIC, Hua Hong, and Yangtze Memory) as well as the increasing demand for automotive semiconductors and IoT applications. At the same time, the U.S. Trade Representative announced the imposition of tariffs on a list of goods in the first phase (including semiconductor components, subject to an additional 25% tariff). Amidst the rush to stock up before the tariff hike and the “de-Americanization” effect resulting from the Huawei ban, the overall inventory levels in the semiconductor industry continued to decline, reaching a bottom in December 2019 (17.72%) and falling below pre-trade war levels (18.24%).
Subsequently, due to stock replenishment driven by lockdown measures (18.46%), the emergence of remote business opportunities, the impact of extreme weather on manufacturing capacity, and the just-in-time production strategy employed by major automakers, there was a panic of shortage. Downstream players aggressively stocked up or placed double orders to ensure uninterrupted short-term supply, resulting in a steep rise in overall inventory levels in the semiconductor industry since 2021. As of the end of the third quarter of 2022, inventory levels remained at a high point (26.43%), despite the sluggishness in the end-market.
To go back to pre-pandemic inventory levels (19.37%), it may take a year and a half to liquidate the existing inventory. In other words, the likelihood of the semiconductor industry’s inventory levels returning to their low point in the short term is relatively low.
Conclusion
Due to the high inventory levels in the semiconductor industry and sluggish demand in the end markets, several risks are expected:
- Companies may resort to price reductions to improve inventory turnover, but this can weaken revenue and profitability due to decreased ASP.
- Increased product obsolescence and higher warehousing costs can squeeze gross margins.
- Weakened downstream pull-in capability can lead to excess capacity and idle production capacity, further pressuring gross margins.
- Short-term fund accumulation due to inventory and potential contract default penalties can reduce operational cash flow flexibility.
These factors collectively highlight the complex and uncertain situation that the semiconductor industry faces in managing inventory levels and sustaining profitability, but the ongoing changes still require continuous observation to confirm the industry outlook.
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