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Chip industry defies optimists as it conforms to historical patterns

Lim Hui Jie
Lim Hui Jie • 8 min read
Chip industry defies optimists as it conforms to historical patterns
Chipmakers like TSMC have been forced to pare back on their fab expansion plans due to the weakening semiconductor market. Photo: Bloomberg
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The semiconductor industry is infamous for its boom-and-bust cycles. Demand surges, chipmakers promise new capacity, new chips fill up warehouses and supply chains. This then creates a glut, causing prices to drop and sales to crash.

At the start of this year, the industry seemed unstoppable. Demand growth was skyrocketing, contrasting with capacity struggling to catch up after caps were put in place amid the pandemic. This led some observers to predict that it will be different this time around, and that “sustained growth” will now be the norm for the industry instead. After all, semiconductors have pervaded everyday life, from cars to manufacturing and even clothing.

As current data shows, old habits die hard. A quick look at The Edge Singapore’s coverage and readers will have noticed that chipmakers were sounding the alarm that demand’s weakening and that the down cycle is here again.

The industry players echoed one another in a whole series of related reports. On June 5, automakers like Mercedes, Daimler and BMW are said to be getting enough of the high-tech components to produce their cars at full capacity, after experiencing crippling outages for months.

ASML, the market leader which manufactures extreme ultraviolet (EUV) lithography machines that etches out circuits on wafers, has cut its revenue growth guidance in half for 2022 because fast-track shipping of its chip-making machines led to delayed sales recognition.

On Jul 28, Intel Corp CEO Pat Gelsinger slashed sales and profit forecasts for the rest of the year, following a PC slump and an unexpected 16% drop in revenue from expensive server chips that power data centres dragged down overall sales and profit. Prices are falling and customers have been turning to rival providers for their orders, Intel said.

See also: SIA chalks up another record year, but further gains will be tougher

Elsewhere, Korean chipmaker Samsung also missed estimates in June, after cooling demand for consumer gadgets hit its chip division, as well as its rival SK Hynix.

The collapse continued into the third and fourth quarters of 2022, with the Semiconductor Industry Association reporting that world chip sales growth has decelerated for six straight months. This is yet another sign the global economy is straining under the weight of rising interest rates and mounting geopolitical risks.

Companies like Micron and Nvidia declared that demand was falling off rapidly, and in October, SK Hynix announced it will cut its capital expenditure for next year by at least half after reporting a 60% decline in third-quarter profit.

See also: Chip recovery to help manufacturing turn corner in 2024

Most notably on Oct 13, TSMC slashed its 2022 capital spending target by roughly 10% to US$36 billion ($48.9 billion), a significant sign for the technology industry from the world’s most valuable chip company.

Geopolitics in the mix

In the last few years, the industry was exposed to externalities other than pure demand and supply. Semiconductor companies find themselves being proxies of a war between China and the US, which was trying to curb the challenges from the former.

As part of the US strategy, it sought to bring semiconductor manufacturing back to its shores, as well as restrict China — which it sees as a strategic rival — from reaching the same technological capabilities that it has. In September, US national security adviser Jake Sullivan opined that the US had to revisit its view that it only needed to stay ahead of its competitors by “a couple of generations”.

“That is not the strategic environment we are in today,” he added, saying “given the foundational nature of certain technologies, such as advanced logic and memory chips, we must maintain as large of a lead as possible.”

Most notably, the US passed its US$280 billion Chips Act in July, which includes US$52 billion of funding to semiconductor companies to build semiconductor fabs in the US.

But for every carrot, there is a stick as well, and a condition of receiving the funding from the Chips Act is that companies have to promise not to increase their production of advanced chips in China.

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Specifically, the Chips Act bars companies from getting federal funding for “materially expanding” production of chips more advanced than 28 nanometres (nm) in China — or a country of concern like Russia — for 10 years.

On Oct 8, the Biden administration went further, imposing a ban on the transfer of advanced US semiconductor technology to China. This affects US firms that sell to China and any company whose products contain American semiconductor technology.

In the latest round of measures by the US Bureau of Industry and Security (BIS), it sought to restrict China from obtaining equipment and tools for high-end semiconductor chips.

This view is echoed by DBS Group Research in a Nov 22 report, which points out that chip wars have global ramifications on chip manufacturers and equipment manufacturers. Based on the export restrictions by the US, both chip manufacturers and equipment manufacturers will be affected.

Given the complex nature of semiconductor supply chains and the Foreign Direct Product Rule (FDPR), the impact of the restrictions goes beyond Chinese companies, says DBS.

The FDPR enables the US government to stop a product from being sold if it was made using American technology, and this includes products manufactured in a foreign country. For instance, Taiwanese chip manufacturer TSMC faced restrictions in selling advanced chips to Huawei without a license, as the product manufacturing process included US technology.

More specifically, DBS sees that Chinese chip companies are likely to be the hardest hit in the ongoing chip war between the US and China.

“Among Chinese companies, we see the most impact on chip manufacturers (IDM/fabless) followed by the foundries,” says DBS. “We do not expect a material impact to equipment manufacturers and software developers, as China’s current technology is way behind the thresholds mentioned in the latest curbs.”

On the other hand, more global companies will be better off due to mitigating factors, such as temporary licenses, relatively smaller contributions from advanced chips and related equipment from China, and companies exploring options to bypass the US ban such as the modification of chips and production processes.

Weakness ahead

Given weakening demand, falling prices and geopolitical tensions, how may the market look in 2023? Not too great, according to London- based research company Omidia. The company noted that following a record run of eight quarters of growth, the semiconductor market has cooled down and consumer confidence has waned resulting in a historic drop for a third quarter.

Omidia senior research analyst Cliff Leimbach says that different parts of the market are driving the weakness at different times. The decline in the second quarter of 2022 was driven by a weakened PC market, with Intel declining 17%.”

However, the decline in the third quarter of 2022 is due to weakness in the memory market. Leimbach says, “Memory revenue is down 27% q-o-q as data centre, PC, and mobile demand declined in combination with inventory adjustments from customers.”

Oxford Economics shares a similar view, that ‘the semiconductor cycle has already turned and is likely to continue softening into next year.”

According to Alex Holmes and Lloyd Chan, the research firm’s senior economists, the world’s largest producer of chips, Asia is set to bear the brunt of the hit to growth.

They also reiterate the point that this hit is unlikely to be uniform overall and will depend on the type of chips each country produces. “We are therefore more pessimistic about the industry in South Korea and less so in Taiwan.”

A weaker phase in the chip cycle will also have additional knock-on effects, like causing regional exports to decline. The economists forecast that regional goods export volumes will contract by around 4% next year, which would be about 5.5 percentage points worse than the pace implied by their 1.3% global GDP growth forecast for next year.

Weaker chip exports will also weigh on investment. While long-term projects and strategic plans backed by governments will soften the blow, semiconductor capacity utilisation has already fallen sharply, which will likely be a headwind to fresh investment plans.

Overall, Holmes and Chan say that the turn in the semiconductor cycle is yet another headwind amid the unprecedented mix of challenges Asia faces, and they forecast that the region is entering a much more difficult phase in its post-pandemic recovery.

Market vs industry

Investors may want to look ahead to the current near weakness and take the opportunity to accumulate semiconductor stocks, says DBS in a Dec 7 report.

Stock markets tend to be forward indicators and this phenomenon has been known to apply to the semiconductor industry too.

DBS points out that the PHLX Semiconductor Index (SOX), which is composed of the 30 largest US-quoted companies in the semiconductor value chain, has traditionally led the semiconductor industry. The SOX, which measures the share prices, started the downtrend in Jan this year, while the current peak for shipment data, which measures the industry’s output, was in May, says DBS.

Over the past years, the upcycle, with positive y-o-y gain, usually lasts longer than the downtrend, and the gap between the industry and the stock market is usually less than a year. “The Asean markets tend to leverage on the global market. Hence, the stock market could recover before the industry. Hence, we expect the technology stocks to recover in 2023 after a battered year in 2022, ahead of the industry,” says DBS.

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