Protracted global chip shortage extends sector’s cyclical upturn

Evidence is growing that semiconductor supply constraints will persist longer than anticipated, intensifying and likely extending the current cyclical upturn into next year, says Fitch Ratings. Lean inventory throughout the semiconductor supply chain, due to plant shutdowns and customer order cancellations at the onset of the coronavirus pandemic, and insufficient capacity as semiconductor demand began accelerating at a stronger than expected rate, drive the global chip shortage. Chip industry revenue should return to pre-pandemic levels this year, as a result of strong demand and pricing, and benefit from greater visibility into 2022, supporting semiconductor credit profiles.

The industry originally expected the chip shortage to dissipate during 2H21 as foundries ramped up production. However, supply constraints are being exacerbated by recent event-driven production issues, including the Texas storms in February, a fire at a Renesas Electronics (BBB-/Rating Watch Negative) plant in Japan in April and the water stress caused by Taiwan’s extended drought.

In response to shortages, chip foundries are aggressively adding capacity, but the acquisition and validation of chip making tools and production of finished semiconductors have historically taken roughly one year. This could result in rationing available supply among customers and higher prices for many products through 2021. However, we expect structurally higher inventory through the chip supply chain over time, and more strategic engagement between larger customers and chipmakers to reduce risks related to future supply constraints.

The significant uptick in industry capital spending is mainly dedicated to leading-edge capacity, which is used for cutting-edge technology such as 5G, internet of things and artificial intelligence. This includes the vast majority of Taiwan Semiconductor Manufacturing’s (TSMC) $30 billion 2021 capital spending budget. TSMC increased its capital spending budget 50% yoy from 2020, at which time the foundry curtailed the increase to the high single digits.

Foundries are also adding trailing-edge capacity, the technologies on which semiconductor products for cyclical end markets, including automotive and industrial, more acutely affected by the chip shortage. Auto manufacturers have significantly cut auto unit production, citing the shortage of chips, the content of which has increased sharply over time but also meaningfully heightens supply chain complexity. Shortages have also become more widespread for other end markets, ranging from consumer electronics, home appliances and construction equipment.

Federal policy is also incentivizing the buildout of semiconductor infrastructure in the US to increase domestic supply amid trade tension with China. President Joseph Biden signed an executive order in February to help create more resilient and secure supply chains for critical and essential goods such as semiconductors. Moreover, the administration’s $2.3 trillion infrastructure bill includes $50 billion for semiconductor production.

The industry’s solid operating and financial performance through the pandemic validates the resiliency of semiconductor credit profiles through deep cycles. This was also demonstrated during the financial crisis of 2008, albeit also within the context of significant government intervention and stimulus. Our forecast reflects intensified investments and the resumption of capital returns across the industry, following two to three quarters of optimizing liquidity in the face of heightened pandemic-related uncertainty.

Fitch continues to focus on rating semiconductor issuers through the cycle, and does not believe the current cyclical upturn strengthens semiconductor credit profiles longer term, just as pandemic-driven lockdowns did not structurally weaken them. However, for certain companies the recovery provides a backdrop for the resumption of issuer-specific positive rating momentum. Fitch recently revised the Rating Outlooks to Positive from Stable for Micron Technology (BBB-) and NXP Semiconductors (BBB-). Fitch Ritings