For semiconductor manufacturers, production is represented by the semiconductors sold (COGS) and any change in inventory. Since the business has high operating leverage, producing more chips in any given period means each chip costs less. This in turn tends to boost gross margin when production levels are high.

The problem arises when the company is producing more than it can sell, which is what made me bearish on semiconductors over the last year.  By comparing production to sell-through (COGS) it is possible to identify companies that have been producing more than they can sell and hence may see margins fall. It is also useful to identify those whose profits will rise because they need to increase production in order to meet demand.

Continuing my series on semiconductor inventory trends, I used Zacks Research Wizard to calculate production levels relative to COGS for nearly 40 semiconductor companies.

The five companies with the highest production levels relative to sell-through are Actions (ACTS), Cypress (CY), Monolithic Power (MPWR), Micron (MU - Annual Report) and MicroSemi (MSCC). These companies may face gross margin pressure as they wait for demand to catch up with production.

The five companies with the lowest production to COGS ratio are Applied Microcircuits (AMCC), PMC-Sierra (PMCS), Silicon Image (SIMG), Conexant (CNXT) and Anadigics (ANAD). These companies may see improving gross margin when they ramp production levels up to meet the demand and replenish inventory.

Special mention goes to Large Cap Watch List (Track at Marketocracy) member MEMC Electronics (WFR), whose production levels have been insufficient to meet demand for seven consecutive quarters.

Disclosure: William Trent has a long position in SMH.

Update: The original post contained a data error.
In the interest of digging deeper into the semiconductor oversupply issues, this post continues a series of data gathering on important ratios for companies in the industry. Hopefully the process will provide insight toward the companies better (or worse) positioned to take advantage of the next upturn or weather the downturn.

Yesterday I used Zacks Research Wizard to get the recent Cost of Goods Sold (COGS) and Inventory levels for semiconductor industry participants over the last several quarters. I made some modest limitations on the share volume and market cap, but still ended up with more than 50 names. I used trailing twelve month COGS and the average of the last five quarters (for a beginning, ending and average) of inventory to calculate Days Sales in Inventory.

Higher inventory levels relative to sales indicates a greater likelihood that the company will need to reduce prices, reduce production or take a write-off, all of which would reduce gross profit margin. In this post I compare the current DSI to the DSI in the same quarter one year ago. This should mitigate any seasonal effects, such as ramping inventory ahead of holiday sales, that might distort sequential comparisons.

The companies with the biggest increase in DSI may have the most trouble in the event of an industry downdraft. Even if semiconductor sales remain strong they will need demand to catch up with their current capacity and may not see as much benefit as other manufacturers. The five companies with the largest year/year DSI increase are Silicon Labs SLAB, Applied Micro (AMCC), Zoran (ZRAN), Monolithic Power (MPWR) and Triquint (TQNT).

The companies with the greatest reduction in DSI, by contrast, may be poised for margin expansion as they replenish inventory levels and ramp up production to meet demand. The five companies with the biggest decrease in DSI are Large Cap Watch List (Track at Marketocracy) member MEMC Electronics (WFR), Advanced Micro Devices (AMD - Annual Report), Atheros (ATHR), Conexant (CNXT) and Intersil (ISIL).

The complete list follows.

DSI As Percentage of DSI One Year Ago:

Disclosure: William Trent has a long position in SMH.