The Semiconductor Industry serves as a driver, enabler and indicator of technological progress. Developments in the industry determine the way we work, transport ourselves, communicate, entertain ourselves and respond to our environment. The PCs we work on, the cars we drive, the phones we communicate with, the electronic gadgets on which we watch movies, listen to music and play games on, and the planes and weapons used to transport or protect us use semiconductor devices.
As environmental issues have become more of a concern today, semiconductor devices are being made to reduce power consumption, reduce heat dissipation, capture solar energy, create more efficient lighting solutions, and so forth.
The past decade has seen big changes in the industry, with most players streamlining operations and transferring more routine production to low-cost locations. This led to the development of the Asian market, where most memory production and backend operations have shifted.
However, since innovation remains largely within the country, the sector is one of the biggest employers of labor, with a corresponding significant impact on the overall economy.
End Market Perspective
Traditionally, the consumer and computing markets have been the most significant drivers of semiconductor demand.
The near-term outlook for the traditional computing markets remains bleak, with Microsofts latest Windows OS failing to spur a revival. The negatives (tablet cannibalization, weaker-than-expected spending by both consumers and enterprises) continue to outweigh the positives (cloud computing, emerging market opportunity).
The fact that emerging markets are more price-sensitive is an added negative. Additionally, the macro weakness in developed regions is also impacting certain emerging markets.
With ultra-portable computing devices gaining popularity, the distinction between consumer and computing markets is blurring. Semiconductors are spurring this change, facilitating the convergence. Of course, the consumer electronics market also includes other gadgets such as LCD TVs, Blu-ray players and smartphones.
The Consumer Electronics Association ("CEA") expects global consumer electronics sales to be up 2.7% this year, following better-than-expected performance in 2012. Tablet units (up 45% from 2012), smartphone units (up 17%), notebooks (up 53%) are expected to be the strongest drivers. Other areas of strength include 3D-enabled displays (39%), networked-enabled TVs (34%) digital imaging 22% and set top boxes 13%.
Since these two markets still consume around 60% of all semiconductors sold, they have a significant influence on total sector performance. However, some other markets are gaining prominence.
The automotive end market has been growing in importance, as the consumption of electronic components for safety, infotainment, navigation and fuel efficiency continues to increase. As a result, semiconductors serving this market should grow stronger than the industry over the next few years.
Industrial consumption of semiconductors is linked to GDP growth, which is expected to improve slightly in the U.S. and China while remaining flattish in Europe. Medical Devices (normally included in this segment), lighting solutions and residential construction markets are likely to be stronger. As a result, semiconductor devices that have enabled increased automation and efficiencies are likely to see modest demand.
The wireless infrastructure segment of the communications market has been stronger than the wireline segment in recent times. This segment is expected to remain strong, with Ericsson, Huawei, Alcatel-Lucent and Nokia Siemens remaining in control. Increasing data volumes across the world and infrastructure build-outs in emerging regions have led to many connectivity issues (network congestion, power reliability, privacy and security). The resolution of these issues will translate to positive drivers of semiconductor growth.
The aerospace and defense markets are considerably dependent on government spending and policy making. The commercial aerospace market (which lags an economic downturn or recovery) has started looking up. Production increases should be slightly positive for the semiconductor industry this year.
The outlook for defense spending on the other hand is not encouraging, with electronic weaponry, intelligence systems and basic weaponry remaining the most important. So semiconductor manufacturers serving these markets continue to see mixed results, depending on the customers served.
Demand may be expected to pick up this year, as most OEMs and their channel partners have been reducing inventories and cutting utilization. PC and microprocessor inventory reduction has been significant, but should pick up this year, driven by new product launches. Handset inventory declines were significant exiting 2012, driven by strong demand. Analog, discrete and storage inventories were also pretty lean, according to research firm iSuppli.
Irrespective of the fact that inventories remain lean, we expect production increases to remain conservative, with shipments reflecting consumption, as manufacturers are likely to remember last year when the first half production increases had to be set off with second half cuts.
Still, DRAM demand is likely to increase somewhat, not only because of stronger demand from the PC market, but also its application in mobile devices like tablets and smartphones. NAND demand is also accelerating, with most manufacturers already ramping production (IC Insights). Standard logic will however remain weak this year, but increase thereafter (iSuppli).
Another noticeable trend is the increased outsourcing of manufacturing to foundries, which is giving rise to more concentrated supply from a few companies. This, along with stronger demand should result in firmer prices this year. IC Insights expects the stronger pricing to drive a 50% growth in tablet processor revenues, 28% growth in cell phone processors, 13% in wired special purpose logic, 12% in NAND and 11% in application-specific analog devices.
Demand at the wafer is also expected to be strong, with MEMC Electronic Materials (WFR) projecting a revenue increase of 6.8% in 2013. WFR is the primary wafer supplier to foundries and other semiconductor manufacturers.
Forecast for 2013
According to World Semiconductor Trade Statistics (WSTS) data, there should be positive worldwide semiconductor sales growth of 4.5% in 2013, following the 3.2% decline in 2012. Gartner and IC Insights are close to this, with projections at 4.5% and 6.0%, respectively. iSuppli is more optimistic, predicting sales growth of 8.2%.
The major players in the industry may be categorized into chipmakers (OEMs-whether fabless or otherwise), equipment and material suppliers and foundries.
According to estimates from IHS iSuppli, Intel (INTC) and Samsung remained the top two semiconductor suppliers in 2012. Texas Instruments (TXN) slipped to number four, as Qualcomm jumped from the sixth position in 2011 to the third in 2012.
Toshiba, Renesas, Hynix, STMicroelectronics (STM), Broadcom and Micron Technologies (MU) made up the next few positions with only Hynix and Broadcom advancing slightly. Applied Micro Devices dropped to number 12, behind Sony (SNE), which advanced two positions.
The pureplay Foundry segment has undergone significant changes over the past few years although the top five positions have not changed much, according to research from IC Insights. Taiwan Semiconductor Manufacturing Company (TSM) remains the leader by far, followed by GlobalFoundries and then Taiwan-based United Microelectronics Corp (UMC). Chinese foundry Semiconductor Manufacturing International Corp (SMI) remains at number four, with specialty foundry TowerJazz (TSEM) in the fifth position. Additionally, Intel and Samsung are strong players with leading edge capabilities.
Leading edge investments remain very strong at the market leaders, with the highest investments at TSM, GlobalFoundries and Intel. Capital investments at these three players are expected to increase 17%, 16% and 9%, respectively. Samsung expects its investments to be similar to prior-year levels and UMCs will be down 12%.
Increased investment in capital equipment bodes well for equipment suppliers this year. However, while foundries and memory manufacturers take the lead, spending on the logic side will be slower. SEMI data shows positive bookings trends in the first few months of the year, although growth expectations remain modest at 0.4%. IC Insights is slightly more positive, projecting an increase of 1.8%.
Latest research from Gartner shows that Applied Materials regained the number one position in 2012 driven by stronger demand for its deposition and process control products. ASML Holdings (ASML), which had taken the lead in 2011 as a result of increased demand for EUV tools moved back into the second position. KLA-Tencor (KLAC) occupied the fifth position.
One of the primary beneficiaries of the growth in mobile phones, tablets and the like is ARM Holdings (ARMH), with its power-efficient, low-performance chip architecture. With new versions of ARM chips coming to market, it is likely that the chips will gradually spread to the server segment as well. Others would be Qualcomm, Samsung and Texas Instruments, all of which are big semiconductor manufacturers that use ARM architecture.
Although we remain cautious about Intel's growth initiatives in mobile and believe that the macro situation remains a deterrent to Ultrabook sales, the company's market position, cash balance, technology lead and management strategy are positives. We also look forward to Haswell, which will help sales this year.
Analog companies with a focus on the communications, mobile and networking technologies such as Broadcom Corp and TriQuint Semiconductor may be expected to hold up better than others in the next few months.
The largest foundry, Taiwan Semiconductor is also likely to do well and valuation is attractive. Additionally, the patent war between Apple and Samsung may have Apple moving production to another foundry, and Taiwan Semiconductor could be the beneficiary.
We believe that inventory rebalancing and adjustment continue to date. Given the uncertainties in demand, we think that semiconductor manufacturers will curtail investment in capacity although technology purchases could continue. In this environment, we would avoid investment in equipment companies, such as Applied Materials, KLA-Tencor, Lam Research, etc.