RealMoney Silver - Tech Inventory Waves the All-Clear Flag

Tech Inventory Waves the All-Clear Flag
By Bob Faulkner
RealMoney Contributor
12/7/2007 12:16 PM EST

Once each quarter, I will opine on the state of inventory within the technology and telecommunications supply chain. As subscribers to The Telecom Connection know, I track, analyze and report on more than 450 companies throughout earnings season. At the end, I post a note on RealMoolah. Unlike my note from last summer, we've seen a considerable improvement in inventory throughout the supply chain during the third quarter. It's been a long time coming!

Inventory started to become an issue in the first half of 2006, as semiconductor companies thought they were building to demand after hearing about shortages and extended lead times in late 2005.

However, it was not until the days-of-inventory number from the entire supply chain hit 125 days exiting the second quarter of 2006 that companies publicly acknowledged the problem. From my perspective, having inventory in the 113- to 116-day range is optimal at a macro level.

Unfortunately, the effort to work down inventory was not something I would call aggressive, as you can see in the chart below. After a drop to 121 days in the third quarter of 2006, the drain appeared to clog up for the next two quarters. The number actually spiked up again to 124 days in the second quarter of 2007. Fortunately, we have now had a material decline to 115 days exiting the third quarter of this year.

While the aggregate figure is within my optimal range, the two components of the universe are actually off target levels. Recent history suggests that right around 70 days appears to be optimal for semiconductor companies. What I call the "customers" (all those repositories for inventory on the way to the end-user from OEMs to contract manufactures to retailers) have typically been in the 44- to 46-day range when the supply chain is operating well.

As you can see below, the semiconductor companies exited the third quarter at 67 days of inventory, and that appears to be quite lean for this group, given the holiday production schedules just starting to kick in. That's down five days from the June quarter and the 2006 third quarter.

Over on the customer side, inventory is at 48 days, flat with the year-ago level, but down four days from the 2006 second quarter. This is a little high from my perspective, but with the semi side so low, they balance out.

Looked at from a different perspective, the chart below displays the sequential change (second to third quarter) of actual inventory dollars (not days-of-inventory) for the two groups in 2007 vs. the median over the prior five years.

One of the reasons I look at this information is due to the seasonality of demand. Given the dual impacts of back-to-school and the holiday build, we should expect a certain ramp at different points.

In essence, the semiconductor companies held their inventory flat vs. the second quarter, whereas the median change over the past five years was an increase of 2.9%. The reverse of this situation happened on the customer side. The sequential change this year was 6.1% vs. a five-year median of only 1.7%.

Does it suggest customers are anticipating a stronger December quarter? If that does not come to pass, will the semiconductor companies see weaker orders late in the fourth quarter and into the first quarter of 2008?

Given the level of inventory at semiconductor companies, if the fourth quarter is stronger than some expect, there may well be some shortages in early 2008. However, if orders soften, those same semiconductor companies may wind up being better off (collectively) than in the past given the low levels of inventory today.

Based upon how the holiday sales play out we should get a read in early January as to whether there will be shortages or not. If so, it will be time to buy your favorite semiconductor stock.