- Profit warning from IQE points to a slowdown in key end markets
- Semiconductor makers already carrying lofty inventory worldwide
- Are the supply shortages of 2021-22 about to become a glut?
- Chip stocks have a good record as a proxy for global stock markets
“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,” says AJ Bell investment director Russ Mould. “IQE cites an inventory bulge at customers across the $600 billion-plus global semiconductor industry, which is a fair proxy for worldwide economic activity and, if past performance is any guide, a useful measure for stock markets’ risk appetite.
“This inventory pile-up means that IQE now expects first-half sales in 2023 to drop by some £30 million, a fall of more than one-third from the £86 million in revenues generated between January and June 2022. That suggests there is little or no chance of IQE meeting analysts’ sales forecasts for 2023, where consensus coming into today had pencilled in revenue growth of 8% to £180 million and a modest increase in profits using the company’s preferred metric of EBITDA (earnings before interest, taxes, depreciation and amortisation).
Source: Company accounts, company guidance for 2022 sales from January trading statement, Marketscreener, consensus analysts’ forecasts (from before profit warning on 9 March).
“While IQE is only a small player in the global industry, the latest warning feels ominous for three reasons.
“First, IQE the sharp drop in sales now expected for the first half means that management is already getting out the prayer mat for 2023 and hoping for an upturn in the second half. IQE is not the first UK-quoted firm to express this hope – just this week Spirent, Ibstock and STV have done the same, following Croda, Coats and others – but it does make the company and its shareholders a hostage to fortune if that second-half pick up fails to materialise. And while IQE is expressing greater confidence in the latter half of 2023, thanks to indications of demand from customers, these are presumably the self-same customers who led the company up the garden path in 2022 and obliged IQE to issue profit warnings when incoming business levels undershot expectations. Industry specialists are busily cutting their global sales forecasts for the semiconductor industry in 2023. They are now looking for a 12% drop in 2023, having started the year looking for a decline of just 3%.
Source: WSTS, SIA, Gartner, Statista
“Second, expressing worries for the first half because of an inventory bulge but hopes for the second clearly assumes that inventory bulge will quickly come under control. Whether IQE is referring to excess piles of unsold end-product or unused semiconductors is not clear, but a study of the balance sheets of the 30 companies which make up the Philadelphia Semiconductor index, or SOX, suggests there is a quite horrendous back-up in the supply chain somewhere – and this is a big change from the last two years, when chip shortages and calls for increases to supply have been the dominant themes.
“The balance sheets for the 30 SOX stocks for the end of 2022 made for sorry – and worrying – reading.
“Yes, aggregate sales for the 30 SOX stocks were flat year-on-year in the final quarter of last year, a far cry from the 20%-plus growth rates that characterised 2020, 2021 and very early 2022. But worse, net profit dropped 15% as chip and chip equipment makers began to wrestle with an inventory bulge of their own. Supplies of unsold product on their balance sheets swelled by 8% quarter-on-quarter and 42% year-on-year.
Source: Company accounts in aggregate for all 30 SOX index members
“That took inventory days to 142 compared to just 99 in Q3 2021. Either the chip makers have increased capacity too much too quickly, or end demand is slowing, or the truth lies somewhere in between.
Source: Company accounts in aggregate for all 30 SOX index members
“But 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.
“If IQE’s warning means that there are piles of unsold mobile phones, tablets, computers, cars and other gadgets lying around on top of unsold chips, then the industry may have a problem on its hands, especially if forecasts of a global economic slowdown prove accurate.
“And this is the third and final reason why IQE’s latest profit warning matters to investors: the SOX index can be a good guide to investors’ risk appetite and global equity markets, at least judging by the past two to three decades.
“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.
“The SOX almost halved from peak to trough in 2022 but it has rallied by 40% from the autumn lows. Perhaps last year’s slump prices in a lot of bad news already, although it may be that earnings forecasts upgrades are needed if the SOX is to sustain its upward momentum. The index has now gone nowhere fast for a month and perhaps the weight of downgrades – and those inventories of unsold chips and equipment – are starting to tell.
Source: Refinitiv data
“IQE is not immune to 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, it is noticeable that IQE’s shares have round-tripped from the start of 2020. COVID-19 and lockdowns stimulated demand for electronic equipment, thanks to the mix of working from home, lockdowns, stimulus cheques, furlough schemes and the need for something to do, be it productive, entertaining or both. Perhaps chip and chip equipment makers mistook that unexpected two-year boom to be the ‘new normal’ and promptly overdid production in response to calls for supply from hardware and gadget makers, only to be caught out as workers returned to the office (at least partially), central banks and governments reined in monetary and fiscal stimulus and inflation took its toll on consumer confidence. 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 2023 develops.”
Source: Refinitiv data
