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 member MEMC Electronics (WFR), whose production levels have been insufficient to meet demand for seven consecutive quarters.
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