Applied Materials (AMAT) Comments at Odds With Some Data

On yesterday’s earnings conference call, Applied Materials (AMAT - Annual Report) CEO Michael Splinter said that foundry capacity is getting tight. While this certainly may be true, recent data points indicate a different picture. In the end, the comment may be right when applied narrowly but misleading as an indicator for overall semiconductor industry spending.

Before elaborating allow us to briefly define a few of the terms, as we believe the CEO’s statements may, like another recent famous statement, depend on your definition of the word “is.” Or at least “foundry.” To start with, Applied Materials sells equipment used to make semiconductors at fabrication plants, or fabs. A foundry is a fab that is available on a contract basis to companies that do not have their own fab capacity. These companies, such as Silicon Laboratories SLAB, are said to have a fabless model.

So when Michael Splinter says foundry capacity is getting tight, he may not be saying that overall production capacity at all fabs is tight. Further, since the foundries are primarily based in Asia they do not show up in some of the economic data that contradicts the overall point. However, the foundries are an important part of the business. UBS estimated that foundries accounted for nearly 30 per cent of total industry capital spending in 2004.

Now let’s compare the tight capacity comment to recent economic data. The obvious place to start is yesterday’s Capacity Utilization report. The latest reading shows capacity utilization at just over 70 per cent. It has been steadily declining since late 2004, when it was above 83 per cent. It is far from the bubble peak of 98 per cent.

Next we turn to yesterday’s PPI report.  This chart details the year/year percentage change in prices for semiconductor and related device manufacturing. If capacity is tight it should be reflected in higher prices. Here we do see a recent uptick, but in general prices have been declining more rapidly (they are always declining) since late 2004.

So taking as a caveat that the comments may be specifically related to a customer segment that may not be measured by this data, investors should be aware that the overall outlook for semiconductor is less clear than the tight capacity headline suggests. Further, we believe that at some point capacity becomes capacity, irrespective of the present owner. If there is excess capacity at integrated manufacturers, it can be used to compete with anything being produced at the foundries. And at that point, whether capacity is tight at the foundries could become moot.

Disclosure: William Trent has a long position in SMH.

Like this article? Why not try out:

•  RSS or email subscription to my free content

• Or buy my book: Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements