The Electronics industry is beginning to stabilize, but several key sectors are still teetering between success and stagnation. By Bolaji Ojo and the editors of EBN EBN (07/07/03 02:07 p.m. EST)
Calmer seas at last. Survivors of the electronics industry's worst downturn are emerging into a new environment of steady if unspectacular revenue growth, rising profits, and a slow return of IT buyers to the equipment market.
No one is claiming the ship has reached a safe haven yet, but many industry executives are content with just being able to report an end to the dizzying sales declines that characterized the past two years.
"There's a sense of relief," said Dan Scovel, an analyst at Needham & Co. Inc., New York. "The good news is that things are not deteriorating. The bad news is that there isn't enough visibility and there are no pricing advantages at suppliers."
Despite the lingering uncertainty, there is a recovery under way, although suppliers and equipment vendors continue to be hurt by their inability to raise prices. Evidence of the recovery can be seen in the rising unit shipments being reported across the industry except in sectors like telecommunications where service providers have resorted largely to maintenance-level capital expenditures.
"IT industries have experienced an improvement in profitability over the last several quarters, and demand for their products and services has picked up moderately," said James Glen, an economist at Economy.com Inc., West Chester, Pa.
"Those industries that spent heavily on new computer equipment running up to Y2K are beginning to replace old computers," Glen said. "Indeed, investment in IT equipment has climbed over the last year, according to the Bureau of Economic Analysis."
The second half of the year will test the strength of the recovery and probably provide clearer evidence concerning which industry sectors are leading the upswing. Executives expect continued strength in wireless where new products like camera-equipped mobile phones are drawing consumers back to showrooms.
Other areas remain less certain, including the PC market where corporations are easing their grip on capital expenditures but appear hesitant to give the go-ahead for the replacement of aging computers. But that situation is better than in the telecom equipment arena. Telecom companies and equipment vendors led all of U.S. manufacturing in capex cutbacks between 2000 and 2002, accounting for "about half of the decline in total industry capital spending," Glen said.
"Telecommunication services companies are still slashing capital spending at a double-digit rate," he said. "The telecom industry is now spending well below the historical average relative to sales."
But not even the telecom market is blind to the need to raise capital spending sufficiently to meet service obligations. Next year, telecom will begin to increase capital expenditures, for the first time since 2000, according to iSuppli Corp., El Segundo, Calif. But industry executives warn that telecom is unlikely to regain its former strength anytime soon.
"I'm reasonably optimistic that we're not going to be singing the blues and talking about continued slips and slides in capex and revenue," said Brent Little, senior vice president of marketing at communications IC supplier Applied Micro Circuits Corp., San Diego. "I think that's mostly behind us, but I would caution on calling it a snapback."
The same could be said for the general economy. With SARS and the Iraq war receding, the global economy appears set for a stronger second-half performance led by the United States. But as in the electronics industry, where executives in many cases still don't know how close they are to strong growth and profitability--and are therefore hesitant to offer anything more than quarterly revenue guidance--the U.S. Federal Reserve Board continues to take out additional insurance on the economy through interest rate cuts.
Fiscal and monetary stimulants will help the economy erase the negative effects that SARS and the war in Iraq had on economic activities during the first half of the year, according to economists.
"It may be difficult to fathom, given the U.S. economy's myriad problems, but more than two years after the beginning of the latest recession, and a full three and a half years after the bursting of the stock market and technology bubbles, the dark clouds that have enveloped much of U.S. business appear to be lifting," said Irwin Kellner, an economist at Economy.com.
"Fiscal policy is working in tandem with monetary policy, when it comes to pushing the economy ahead," Kellner said. "All of these will put buying power into the hands of businesses, consumers, and investors, which, along with an improvement in confidence, should lead to stepped-up spending beginning later on this year and continuing into 2004."
Semiconductors
A group of analysts, researchers from the Semiconductor Industry Association (SIA) among them, are predicting that the chip sector's stubborn malaise is poised to lift in the second half of the year. But in a sign of just how difficult it is to pinpoint the market's recovery, other observers are painting that projection as either overly optimistic or too conservative.
Last month, the SIA said it expected global semiconductor revenue to increase 10.1% this year, to $155 billion, and to jump 16.8% in 2004, to $181 billion, with growth continuing unabated into 2006 when the industry will reap revenue of $205 billion.
However, Bill McClean, an analyst with IC Insights Inc., Scottsdale, Ariz., believes the SIA numbers may prove too cautious. IC Insights projects 15% growth this year, predicated in part on a strong fourth-quarter PC upgrade. The research firm said 2004 will come on even stronger, registering revenue growth of 25%.
"I've had a flashback to '99, when we had forecast 13% growth for the year, and in June it was flatter than a pancake," McClean said. "At that point no one could foresee that the second half would be the boomer it was, with a 13% sequential increase in the third quarter and a 17% increase in the fourth quarter.
"Then, going into 2000, everyone was projecting 22% to 25% growth, including ourselves, and it came in at 36%," he said. "I look at the SIA forecast for 2004, and with any sequential growth through this year, their 16.8% growth next year assumes almost no growth on a quarterly basis. That is so ultra-conservative. But no one is willing to go out on a limb and project 30% growth for the industry."
McClean said even some bad news in the first half of this year could hold better tidings for the final two quarters of 2003.
Nokia Corp. lowered its cell phone growth expectations for the second quarter but not for the year as a whole. Slowing growth attributed to the SARS epidemic appears to be coming to an end, leaving a market in Asia with pent-up demand.
Also, while semiconductor ASPs have been weak, unit volumes are nearing record numbers. Tax rebates and paycheck withholding decreases in the second half of the year could improve the U.S. economic outlook, and tax laws are providing incentives for capital equipment purchases between now and the end of 2004.
"The IC industry is typically a second-half industry, and so is the electronic systems industry," McClean said. "I think we're looking at a better second half, and now everybody is just trying to determine how much better."
Other analysts remain more conservative, waiting for more concrete signs of the anticipated rebound.
"There's not a lot of money breaking loose anywhere," said Tom Starnes, an analyst at Gartner Dataquest in Austin, Texas.
"We're talking about 9% growth, but last year was essentially flat, and that's not really growth," Starnes said. "This has been an extended trough that we're having a very difficult time crawling out of.
"You keep hearing companies talking about things like a jobless recovery.' Everyone has gotten to the point where any little uptick is good, but it's certainly not swing open the doors, hire the people back, repaint the offices, and upgrade the PCs.' "
Mike Feibus, an analyst with Tech-Knowledge Strategies Inc., Scottsdale, said that companies and individuals in the industry are tending to be more optimistic, "but what I haven't seen is a compelling reason why.
"Certainly Wall Street, which has been pretty morose for three years, seems to be moving in a positive direction. But overall, I think we're looking at only a small uptick in the second half, and it will be next year before things really start to come back."
Still, Will Strauss, an analyst with Forward Concepts Co., Tempe, Ariz., said there are indications that the "nuclear winter" that has frozen the telecom industry might actually begin to thaw late this year, as much as six months earlier than anticipated.
"There are bright spots on the horizon, but there is no barn-burner," Strauss said. "We're beginning to see people actually investing again in capital expenditures, so there are signs of life out there."
- Darrell Dunn
IP&E
The stagnant market for passives, interconnects, and power products is not expected to improve in the second half, with some suppliers writing off recovery until 2004 as weak demand and price erosion continue.
Though suppliers believe the worst is behind, that doesn't translate in their estimation into a marked rebound, particularly after industry hopes following a second-quarter 2002 uptick faded quickly as conditions worsened during the remainder of the year.
"We don't anticipate much of a second-half recovery," said Steve Goldman, chief executive of power supplier Power-One Inc., Camarillo, Calif. "Things are past the bottom and we are doing a bit better, but enterprise spending won't come back until demand does."
Power-One expects conditions to improve on the other side of 2003. The company hopes to begin generating revenue in 2004 from its SPS division, formed in April to capitalize on the growing market for point-of-load DC/DC power converters.
Similarly, Steve Wade, director of sales and marketing manager for passive component supplier IRC Inc., Corpus Christi, Texas, expects slow market conditions to prevail. "Business has been flat the last nine quarters. Some months see an upside, but business just flattens back out," he said.
Expecting little or no improvement, some companies continue to batten down the hatches, keeping a lid on costs and capital spending.
Connector and component maker Molex Inc., Lisle, Ill., cut a total of 550 jobs at several U.S. and European fiber optic component plants at the end of May.
"Visibility is still poor," said Joseph King, vice chairman and chief executive of Molex. "My view is based on a pretty flat horizon. I just hope customers spend."
The lingering effects of SARS, particularly in Asia, will likely affect companies' attempts to keep inventories lean.
"There's been accumulation of handsets at carriers," said John Denslinger, vice president of sales for Murata North America Inc., Smyrna, Ga. "There's also been a scale-back in the automotive market."
Relentless price pressure
But demand is only half the story, say suppliers and analysts, who note that unit sales are gradually improving. The main problem is relentless OEM price pressure.
"Our customers expect continued price reductions," said Darrell Wilk, vice president of marketing and sales for ITT Industries, Cannon Switch Products, Watertown, Mass. The company is experiencing price erosion in the low single digits for its switches, he said.
OEMs are now entering contract negotiations armed with the very latest price information, further adding to downward pressure, said Murata's Denslinger. "Just a year or two ago, customers would find out what the latest prices were within a month. Now, they know within a week."
Prices will continue to drop for the foreseeable future, according to Patrick Parr, an analyst with USB Warburg LLC, New York. "Talk of capacity expansion from existing Asian suppliers and the inevitable emergence of the domestic Chinese supply base will likely pose significant hurdles in the road to recovery," Parr said in a report.
"In passives, capacity utilization is probably 40% to 70%, depending on the product," he said. "There isn't any visibility from the customer to suggest a pickup is coming."
Overcapacity and soft demand will combine to keep lead times from stretching.
Stocks of most commodity components are maintained to six-week lead times, according to Murata's Denslinger. "There was a slight pickup in distribution activity part of the first half, but orders have fallen in the past month."
Inventories of some specialty parts, however, could tighten as OEMs redesign their products, according to a spokesman for passives vendor Kemet Corp., Greenville, S.C.
"We've started to run into some inventory issues with some high-capacitance ceramic capacitors and high-performance tantalums," he said. "But there are no allocation issues."
As the effects of SARS fade, suppliers will continue to relocate production to lower-cost Asian countries like China.
"We're expanding the capability we have in Asia," said Wilk, adding that ITT maintains six plants in China.
Similarly, Kemet is slated to ramp up its first China plant during the second half.
- Spencer Chin
Distribution
Economic weakness in Asia attributed to the SARS outbreak hindered distributors' growth during the first half of the year as some orders scheduled for delivery between February and May were postponed by wary customers.
The delayed growth, even if modest, is likely to resume in the second half, according to distribution executives. In addition, fairly upbeat manufacturing reports and improving customer sentiment have raised hopes that the recovery could finally be picking up steam.
Distributors can use a little lift. The first six months of the year were marked by more layoffs, pay cuts, and weak pricing. Although sales rose on a unit basis, the poor prices ate into margins and deprived distributors of much-needed profits.
Industry executives said that the market appears to have stabilized, leaving pent-up demand that could result in stronger sales during the third quarter.
"This probably sounds crazy, but I think we're in what I'll call the bigger wheelhouse of the turnaround, and believe the upturn is upon us," said Andy Bryant, president of Avnet Electronics Marketing, the components arm of Avnet Inc., Phoenix. "The Iraq war and SARS appear under control, and I believe we're heading into a much better second half."
With unit demand still climbing, industry observers believe pricing should stabilize while lead times may begin stretching out for certain commodities. Power-management and high-end analog products are already witnessing this, and the mobile PC and wireless markets are gaining momentum, Bryant said.
World Peace Industrial Ltd., a Taiwan distributor, is forecasting a recovery in the next six months and estimates the company is on track to report sales of $1.3 billion for 2003. Roughly 55% of the revenue will come in the second half, according to Mike Chang, chief executive of WPI parent company World Peace Group.
Single-digit growth for desktop PCs and double-digit growth for notebooks and PC- related products such as wireless applications and graphic cards will help WPI achieve this goal, Chang said.
Memec optimistic
Executives at Memec Group Holdings Ltd. are singing the same song. The company has strong expectations for wireless and networking products, mostly in the Asia-Pacific region. In Japan, demand for 3G wireless products is picking up, compared with the handset business in China, some industrial applications in the Americas, and telecommunications in Europe.
"In the last two months, surprisingly enough, there were supplier lines in the telecommunications space delivered to customers to which we haven't sold these products in more than a year," said David Ashworth, chief executive of Memec, San Diego. "We believe this will continue."
Similar developments are being reported at smaller distributors. Symmetry Corp., a $16 million North American distributor headquartered in Hawthorne, Calif., said rising demand from the telecommunications, wireless, and networking markets will boost its revenue 20% this year.
"We're starting to see more business and designs being funded in the wireless and networking space," said Joe Caravana, Symmetry's president. "People are beginning to talk seriously about new products, making us optimistic about the second half."
While distributors are optimistic that the recovery is going to pick up in the second half, executives are hesitant to call it a full-blown upswing and are uncertain about its magnitude, according to Brian Alexander, an analyst at Raymond James & Associates Inc., St. Petersburg, Fla.
"The economic picture continues to improve at a modest pace, and the hope is that chief financial officers will open the purse strings and be more willing to allocate funds for IT projects," Alexander said.
But the outlook is mixed. Interconnect and electromechanical distributor TTI Inc. anticipates an increase in unit demand through 2003, although the company is concerned that pressures on margins and pricing may remain.
"We don't see any clear signals to indicate a positive or negative second half," said Mike Morton, senior vice president of global product marketing for TTI, Fort Worth, Texas. "Unit demand, available inventory, capacity utilization rates, the health of the economy, and backlog are so mixed that it's very difficult to determine the next part of the cycle," he said.
Even with data released in May for the high-tech sector suggesting that businesses are gradually buying equipment to upgrade worn-out machinery, Newark InOne doesn't expect much more in North America than stock replenishment. About 75% of the Chicago catalog distributor's customer base are design and maintenance engineers.
"There are segments in design and maintenance where we still see growth, but we don't see capital equipment purchasing returning to drive demand dramatically," said Jake Ring, Newark's senior vice president of marketing for the Americas.
"We are providing products to maintenance engineers where there's an emphasis on extending the life of the company's capital equipment," Ring said. "We expect to see in the remainder of the year a greater spend for products like twin-lead components to maintain and repair equipment, but not much."
- Laurie Sullivan
EMS
Despite knitting closer relationships with customers and reports of a smattering of new client wins, EMS providers were unable to excite revenue growth in the first half of the year.
As the second half begins, OEMs are still complaining about a lack of visibility into end-market demand, while the recession-weary EMS sector expects flat to slightly higher revenue growth over the next six months.
"There is no catalyst to suggest a robust recovery in the second half," said Bob Bradshaw, chairman, president, and chief executive of contractor Manufacturers' Services Ltd., Concord, Mass., during a meeting with analysts at a financial conference in New York last month. "It's a back-end-loaded year for the EMS industry."
Demand for telecom equipment from major OEMs such as Nokia Corp. and Nortel Networks Corp. is expected to be flat during the second half of 2003, said Thomas Hopkins, an analyst at Bear, Stearns & Co. Inc., New York. However, corporate spending on information technology projects could shows modest improvement, he said.
"Corporate IT spending is flat, but is slightly up for high-end computing and storage," Hopkins said. "Also, the second half could see more consumer spending for back-to-school in September and Christmas, depending on interest rates."
Hopkins believes the EMS industry's second half will be "slightly better" than the first half because concerns about the SARS outbreak peaked in the second quarter and Asian consumers who were afraid to leave home because of the disease could increase their purchasing during the fall.
"I think the second half will be better because you always have seasonality as a factor," said Shawn Severson, an analyst at Raymond James & Associates Inc., St. Petersburg, Fla. "You also have a moderate budget flush that could occur similar to what happened last year. Plus, there's more optimism out there from the customer base, which might lead to moderate purchasing."
Thomas Smach, senior vice president of finance at Flextronics International Ltd., also sounded a positive note. "Our business is more stable, so the second half of the year should be better," he said.
During an earnings conference call with analysts last month, Mike Cannon, Solectron Corp.'s president and chief executive, said the Milpitas, Calif., contract manufacturer saw "more revenue stability and less volatility from customers" during its third fiscal quarter, ended May 31.
"We won 13 new customers in the quarter," Cannon said. "Existing customers awarded new business that replaced programs that were going end-of-life."
However, Solectron's third quarter also brought a wider net loss than the year-ago quarter. The company, which is continuing to restructure its operations, reported a third-quarter net loss of $3.1 billion vs. a net loss of $284 million in the same quarter a year ago. The latest loss came on revenue of $2.8 billion, compared with $3 billion in the year-ago quarter.
Raymond James' Severson maintained that EMS companies can expect a moderate economic rebound in 2004.
"I don't think the real teeth of the rebound will be felt until next year, when we'll see stronger quarter patterns and sequential improvements," he said. "Claire Serant
The OEM outlook as the first half of 2003 drew to a close was mixed, and that probably won't change much in the second half. The telecommunications equipment market is still floundering, additional cuts in capital expenditures lie ahead, and there are few killer applications on the horizon.
Even in the previously fast-growing mobile handset and PDA sectors, there are indications of a slowdown. In May, Gartner Dataquest lowered its 2003 PDA sales forecast to approximately 12 million units, unchanged from 2002 but below the San Jose-based research firm's prior estimate of 13.4 million units.
Mobile handset sales are climbing, but carriers' capital expenditures have stagnated. Despite an increase in new subscriptions, service providers are more interested in maintaining current equipment than swapping for newer gear despite warnings from analysts that they may later pay a hefty price in degraded service and consumer rebell.
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