Macquarie Research, Semiconductors: At the cycle bottom

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Semiconductors: At the cycle bottom
Event
 We provide a roadmap of how we believe the semiconductor industry cycle
will play out and its implications for stocks. We recommend a positive stance.
Impact
 The end of the downcycle: The semiconductor industry has been in a
downcycle in terms of YoY growth since March 2010. We believe YoY growth
will trough by July, then reaccelerate. As we highlight in this report, this has
historically been associated with an uptrend in semiconductor share prices.
 We note that typical signs of a cycle bottom are occurring, including:
(1) Expectational cuts in the chip sector affecting production and capex plans;
(2) “Lack of visibility” cited – a consequence of order caution that typically
anticipates subsequent order rushes and positive surprises; and (3) Moderation
in sell-side consensus expectations and ratings (which typically coincide with
or lag the share price correction, rather than serve as a lead indicator).
 The worldwide electronics supply chain was rocked earlier this year by fears
of disruptions due to the Japan earthquake in March. This led to precautionary
inventory build-up in certain areas, causing a front-loading of parts demand.
These concerns soon eased, resulting in moderated procurement as the June
quarter wore on. Worries about the macro outlook then curbed chip inventory
accumulation, eg, at non-Japanese chip vendors late in the quarter – as
signalled by cuts to foundry shipment expectations for CY3Q (eg, at TSMC).
 As a result, we expect semiconductor supply-chain inventories to become
lean in CY3Q ahead of the seasonal pick-up in electronics production. We
think this will prime the supply-chain for upside surprises and perceptions of
tighter conditions, backing a return of confidence. Elimination of remaining
supply bottlenecks (eg, of MCUs out of Renesas) and post-earthquake
production recoveries (eg, of cars) would be positive factors for chip demand.
 Expect near-term chip sector capex adjustments: Given the adjustments
to foundry production plans in CY3Q, foundry capex budgets may be trimmed.
Michael Liu suggests a 10-15% cut to TSMC’s 2011 capex budget to
~US$6.5-7.0bn from US$7.8bn. While this will be a sentiment headwind in the
near term, we believe this will pave the way for easier 2012 comparisons,
where we see sustained SPE sales growth of ~5% following ~10% growth in
2011 – backed by sustained chip industry long-term growth of ~6%.
 We expect SPE orders to bottom by CY3Q, and the sector book-to-bill ratio
to climb back above 1.0 by CY4Q. These developments should be favourable
for SPE sector share prices. Worldwide SPE orders previously peaked in 4Q
2010, then slipped 9% QoQ in the March quarter. Front-end SPE orders look
set to fall by 20-30% QoQ in the June quarter before beginning to recover.
Outlook
 We are positive on chip sector shares, and believe the correction since
February should provide attractive entry points for shares in CY3Q. We are
positive on bellwethers such as TSMC, ASE, SPIL, Tokyo Electron, Toshiba,
Samsung and Hynix. Sector valuations do not seem challenging. TSMC for
one is at 12x PER on current year estimates vs the 2005-11 mean of ~14.5x.
 We also expect DRAM spot prices to bottom soon. For an industry analysis,
kindly refer to MacqTech Thematic – Mini-correction in DRAM price (