Bill Snyder

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Tech Recovery Has Been Around for a While

Bill Snyder

In yet another sign that demand for electronic goods is strengthening, the latest book-to-bill ratio for the circuit board industry indicates that demand has stayed ahead of supply for five months in a row.

Taken by itself, the positive book-to-bill (a measure comparing orders to shipments in a given month) is generally seen as a short-term indicator, building on the excitement generated by Intel's(INTC Quote) most recent earnings announcement and surprisingly robust PC sales reports from industry analysts. But other important signals, including order data from the Department of Commerce, show that the recovery may have been well under way for some time.

According to the Commerce Department, orders for computers and other electronic products (excluding chips) have increased five months in a row. The most recent data available show that orders for electronics products increased by 2.6% sequentially to $31.5 billion in September, the largest monthly total since March 2001, when orders totaled $33.4 billion.

By contrast, orders for all durable goods in September increased just 0.8% sequentially.

Leading the recovery in electronics were medical instrumentation, which includes everything from sophisticated diagnostic tools to hearing aids and pacemakers; navigational equipment for defense; automatic controls for heating, air conditioning and refrigeration; testing equipment as well as control, display and monitoring devices for industrial facilities.

Although capital expenditures by major telecom carriers have not been strong, demand for the wireless base stations used by them has been robust, said Needham analyst John McManus.

Meanwhile, the backlog of computer and electronic products also has grown for five months and now totals $127 billion, while the backlog for all durable goods increased by 0.1% in September to $490.7 billion, after dropping by 0.8% in August.

The buildup in back orders confirms the strength of tech demand, said Steven Milunovich, technology strategist for Merrill Lynch. Tech inventories also are down, he said, suggesting that the increase in shipments represent real demand and not a build in inventory.

September's book-to-bill ratio for North American board makers was 1.15 (meaning for every $100 billed, $115 worth of orders were taken), the seventh month this year that the closely watched ratio has been above 1.0, according to the IPC, a trade association. Because circuit boards are the building blocks for many electronic devices, orders for them are considered a leading indicator of demand for electronic goods of many types.

Walter Custer, a Sea Ranch, Calif.-based consultant and analyst, noted that demand for flexible boards, used in a variety of handheld devices and military electronics, increased nearly nine times faster than demand for the rigid boards used in larger products. The smaller boards, however, represent less than 15% of all boards shipped.

Nearly all of the printed circuit boards produced in North America are used in relatively high-end products, such as routers, pricier computers and servers, medical equipment and military applications, while boards for PCs and cell phones are generally made in Asia.

Orders for boards in Taiwan this year will reach about $3.9 billion, up from $3.6 billion last year, said Custer, who tracks the island's nine large publicly traded printed circuit board makers. Unit growth is probably much larger, but price cutting, a problem for the entire industry, held down the dollar growth.

David MacGregor, an analyst with Longbow Research, regularly surveys board makers. "September marks the third consecutive month of improving business conditions and conclusively sets aside any lingering speculation that this recovery is not for real," he wrote in a note to clients. However, he also noted that there are signs of double ordering by large manufacturers seeking to assure adequate supplies of boards, and that could be inflating demand.

The good news on the demand side won't necessarily translate into good news on the earnings side for component suppliers and contract manufacturers. Pricing is still very competitive and is holding down gross margins, said Deutsche Bank analyst Chris Whitmore.

For example, gross margins for the leading contract manufacturer, Flextronics(FLEX Quote), dropped from 5.3% to 5.2% in the September quarter, although revenue was up $400 million.

As has been the case throughout the tech slowdown, large manufacturers are squeezing their suppliers, demanding margin-trimming price concessions.

"Dell(DELL Quote) and Hewlett-Packard(HPQ Quote) are not relenting," Whitmore said.

A shift in product mix also may have contributed to the decline in margins for the company, he added.

As demand grows, though, suppliers will start holding out for higher prices.

As a case in point, EMC(EMC Quote), the large storage vendor, and McData(MCDTA Quote), a much smaller supplier of storage switches, have been at loggerheads over EMC's demand for end-of-quarter price cuts.

So far, McData's reluctance to yield to the larger company appears isolated, but there have been some indications that pricing for electronic components is stabilizing.