Friday, August 05, 2011

Canaries in the Chip Mine

Over the years a number of companies in the semiconductor and semiconductor equipment community have been labeled as "Canaries in the Coal Mine." Back in the mid-90's my partner(s) at INFRASTRUCTURE tagged wire bond equipment supplier Kulicke & Soffa as one of the most important canaries. We had several reasons for doing this:

1) K&S tools are shipped to assembly houses with relatively short lead times.
2) Swings in demand for wire bonding tools typically preceded up and down turns in the semiconductor cycle by a few quarters.

Pretty straightforward stuff….

As time passed we continued to add indicators to our arsenal in an attempt to improve our sense of where the industry was headed. I say "attempt" purposely here because I will readily acknowledge that no set of indicators is perfect. By no means do I want to imply that we nailed every cycle turn. That said, gathering information about run-rates and subtle nuances in the food chain became a centerpiece of our work. "Eclectic" was how some described the collection of data points we accumulated .

Up and down the food chain we searched - starting with raw materials for wafer manufacturing all the way to those OSAT houses (Outsourced Assembly and Test) that were sending board-ready devices to the subcontract assembly business. As for the eclectic, here's a few examples: We would ping companies that supplied the vegetable inkers that were used to mark bad devices during the final testing process - thinking that changes in the demand for vegetable ink (yes, vegetable ink) could be linked to variations in unit volumes. Along the same lines, monitoring die banks at the OSAT houses became important. Companies like Amkor, Silicon Precision Industries and Advanced Semiconductor Engineering often talk about die banks on their conference calls. Amkor's Ken Joyce had this to say on their July 27 call:

"All we can say is what we see, I can’t speak for the entire industry, but what we see is that there has been a buildup in the die banks in our factories, and what does that tell us, and who are the customers that are building in there? Well, they’re actually one step, once the front end makes the decision to put those into production, they take them and they give them to us and that’s good news. I think what we’re seeing there is that our customers and their customers downstream are managing their inventories really very closely, and it probably is somewhat of a reflection of what I talked about a few minutes ago, this cloud of uncertainty that’s started to rise with respect to the demand picture."

The full transcript is here:


Instead of waiting for the companies to tell you what die banks were doing we would check to see if demand was rising for wafer storage containers and die carriers. If demand was jumping there it could be construed that the OSAT houses were shelving processed wafers before they ran them through the test and assembly process - building a die bank. For finished (tested and packaged) devices, demand for die carriers would suggest there wasn't any pull through from their downstream customers.

I could go on because every layer has its own little food chain. Who supplies bearings and actuators for automation systems, metal components for process tools, lasers and alignment components for scanners, etc, etc. This is just a few of the ways to get a pulse on the chip business - that is, if you really want to dig deep.

Most folks have no inclination to spend their days digging around in the semiconductor food chain. It's a lot of work. If you choose that route but still want to have a good idea of what is happening in semiconductor land then I would suggest you tune your attention to Microchip Technology. Microchip has proven to be accurate at calling cycles time and time again. Their management team, in my opinion, is the "Canary in the Coal Mine."

If you would have listened to Microchip when they pre-announced July 11 you probably would have sold every chip-related issue in your portfolio (and been a lot richer today). Last night the company issued their quarterly report and here's what CEO Steve Sanghi had to say:

"We believe that our June quarter results reflect weak overall market conditions, which we believe will impact the broad-based semiconductor industry in the June or September quarter, depending on the individual market exposures and revenue recognition practices of the company. Since then, we have seen this sentiment reflect to the earnings season with a weak guidance coming from Linear, Freescale, Texas Instruments, Silicon Labs, STMicroelectronics, Intersil, Micrel, NXP Semiconductors, IDT, Power Integration and others. The semiconductor supply chain is confirming the same sentiment with weak guidance from TSMC and UMC on the wafer foundry side, Teradyne from the test equipment side, [indiscernible] in Applied Materials from the fab equipment side and Arrow Electronics from the component distribution."

"There could be some companies that are exceptions due to a particular product transition or momentum in a given application segment, but we continue to believe that most companies will see the weakness manifest itself as the quarter progresses and their guidance is likely to be too aggressive."

"The broad-based global weakness seen [ph] has also been reflected by large multinational industrial conglomerates like Emerson Electric Co. Last week's Durable Goods report also cited that new orders for durable goods fell unexpectedly in June and a weak June quarter GDP report and a very weak ISM Index this week caps it all."

"Our long-term investors and analysts have seen Microchip experience these industry events first. Microchip tends to see changes in business conditions earlier than most of our peers due to a number of factors. Number one, we recognize distribution revenue on a sell-through basis worldwide. Number two, we run very short lead times, which gives customers more time to make purchase decisions based on more current business conditions. And number three, we have a large number of small- and medium-sized customers who tend to be quicker in adjusting their inventories."

The full transcript is essential reading for anyone interested in the sector. You can find it here:

I would also suggest that you put the shares of Microchip on your radar screen. In fact, run some comparisons against the other household names in the semiconductor business. Microchip has a stellar track record of profitability, stock performance and a 4.40%+ dividend to boot.

Full Disclosure: I have no position in Microchip or any of the companies mentioned in this note and I won't have any positions until I hear the Canaries singing a different tune.

No comments:

Post a Comment