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The Dreaded Double-Ordering Issue in Semiconductors

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It happens. But at this stage in the cycle, some analysts are concerned.

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Many consider the Philadelphia Semiconductor Index as a proxy for the semiconductor industry and, on a year-to-date basis, it has appreciated about 50%. However, the bulk of that appreciation came earlier in the year. For much of the last 90 days or so, it's largely been treading water, and we've seen some pressure on some semiconductor stocks in weeks following September quarter results. Part of the reason for some of that weakness has been the worry about double-ordering.

It's not like double-ordering never occurs, but at this stage of the semiconductor cycle, the "concern" appears to stem more from analysts who missed the move and/or remain negatively predisposed to the group.

Generally, double-ordering takes place when inventories are low, demand is rising, parts are being allocated and lead-times for future delivery are increasing. OEMs worried about being able to meet their own demand place orders with multiple sources with the hope of getting a sufficient quantity.

Because most semiconductors aren't interchangeable commodities, most double-ordering occurs in those that are. However, OEMs do develop alternative designs that enable them to use functionally equivalent parts that may not be plug-compatible. Even with proprietary products, in a period of limited supply, there's little to prevent an OEM with a need for 100 widgets from ordering them at Distributor A and ordering the same 100 widgets at Distributor B. That leads the semiconductor supplier to think demand is actually stronger than it really is.

Fairchild Semiconductor (FCS) added some fuel to the fire last week on its conference call when it brought up the double-ordering issue. However, its management was attempting to clarify or refute some analyst claims that the practice was occurring at this point. Somehow, that got translated to, "Fairchild mentioned double-ordering."

I've tracked inventory in the electronics-supply chain for years. While it's too early in earnings season to draw any final conclusions, I think it's very safe to say that inventory is quite tight on a relative basis. If you look at the graph below, I break down the total supply chain into its two components: semiconductors and everyone who uses/transports them (OEMs, EMS, distributors, etc.).

What I consider the optimal range for the supply chain is about 113-116 days-of-inventory (DOI) split as follows: 70 days or less at semiconductor companies; and 44-46 days at the customers. We've been in recovery-mode for most of the last year as the industry attempted to rebalance inventory as the recession sent demand south. What we've seen -- and it's quite typical -- is that as demand has improved seasonally, lean channels have gotten even leaner.



That begs the question, "Is this a huge red flag?"

The short answer is no at this point for two reasons: First, with the exception of Texas Instruments (TXN), none of the semiconductor companies that have reported are talking about their lead-times beginning to extend. Even with TI, the issue is constraints in the back-end assembly and test area, and that's being addressed with some new equipment.

The second point is that the industry, in general, isn't running at full-wafer production capacity or close to it. Most companies have the leeway to increase wafer-starts in response to increased demand. Granted, the OEM may have to wait a little while for the parts, but they'll get them. Historically, the double-ordering problems arise when semiconductor companies lack capacity, and for the most part, that's not the case right now.

The one area you could argue that lacks capacity is with memory, and that's by design. Given the bloodbath that has taken place in that segment for the last several years, the memory companies are perfectly content to allow pricing to rise to shore up balance sheets and pay down debt where it's possible. As I noted in an article last week, that's not going to change for a while. See Micron Will Ride the Wave Into 2010.

Overall, the semiconductor industry is just starting to regain its health after a very tough recession. It's not back to its salad days by any means at this point because we're still seeing revenues decline versus the prior-year period. That should start to change in the December quarter and, given the very lean business models in place at most companies, earnings should start heading north very quickly.
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No positions in stocks mentioned.
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