At a time when economies around the world compete to improve their semiconductor manufacturing capabilities and expand capacity, the global semiconductor industry, which has enjoyed robust sales growth during the COVID-19 pandemic, faces an inflation-driven slowdown in demand. Global chip sales growth registered a slowdown for the sixth consecutive month as surging inflation, a tightening interest rate environment, and recession fears reduce demand for consumer products which use semiconductors as a key component. The NUS-CRI Aggregate (median) 1-year Probability of Default (Agg PD) increases consequent to an acceleration in inflation, fueled by geopolitical tensions and global supply chain issues. The NUS-CRI Agg (median) Forward 1-year PD (Forward PD) suggests a worse deterioration in its credit risk outlook as a looming demand slowdown concurrent with capacity expansion weighs on the industry’s margins, with vulnerable firms potentially facing a more rapid deterioration in credit health.
Figure 1 (LHS): NUS-CRI Agg (median) 1-year PD for Global Semiconductor industry from Sep-2021 to Aug-2022 and its interquartile range with reference to PDiR2.0 bounds; Global Semiconductor sales (YoY % growth) until latest available figure of Jun-2022. Figure 1b (RHS): NUS-CRI Agg (median) Forward 1-year PD for Global Semiconductor industry as of Aug-2022 and its interquartile range with reference to PDiR2.0 bounds. Source: NUS-CRI, Bloomberg
Record inflation in major economies around the globe has squeezed consumers’ disposable income, consequently hampering demand for consumer electronics and other discretionary products. As a result, the global chip shortage, which helped boost the semiconductor industry’s bottom line over the past few years, is finally starting to ease. Personal computer and smartphone segments, which are amongst major contributors to semiconductor demand, have experienced a decline in the first half of 2022. The industry has already begun to contend with the consequences of declining demand as major players in the industry such as Micron and SMIC warn of a potential negative impact on earnings in the upcoming quarters. The implications of the slowdown are potentially worse for the more vulnerable firms in the industry (See Forward PD in Figure 1b) which may lack the scale of bigger players and are more vulnerable to fluctuations in demand. Adding to the incumbent pressure on margins, heightened measures by governments around the world during the initial fallout of the pandemic focused on increasing the global production capacity. Aggressive capacity expansion undertaken during the past few years, in conjunction with a potentially prolonged demand downturn, could translate to a build-up in inventory over the next few years, initial signs of which are already being witnessed in Q2 2022. As such, with the prospects of an economic downturn rising in the near future, the impact on margins witnessed by the whole industry moving forward may be hindered, with the industry-wide build-up in inventory affecting prices and turnover in all major products dependent on chips.
Figure 2a (LHS): Present and forecasted number of firms rated as non-investment grade according to PDiR 2.0. Figure 2b (RHS): NUS-CRI Agg (median) Forward 1-year PD for China, US, Taiwan, Korea, and Japan Semiconductor industry as of Aug-2022 with reference to PDiR2.0 bounds. Source: CriAT, NUS-CRI
A closer look at the regional dynamics of the semiconductor industry shows that the credit-risk outlook for semiconductor industries in Taiwan, Korea, and Japan is more stable compared to that in the US and China (See Figure 2b). As geopolitical tensions among them rise, the US and China have been actively investing to bring on additional capacity, with the US senate recently approving the CHIPS act which includes a USD 52bn investment package. In spite of the huge investment that the CHIPS Act brings, the timeline for new capacity additions for the industry is long and may only bear fruit in the longer term. Additionally, the capacity expansion plan of the US semiconductor industry may still face bumps in the form of labor shortages and higher labor costs as compared to its Asian counterparts, which in turn may hamper their margins compared to their global counterparts. On the other hand, the Chinese semiconductor industry is currently facing multiple headwinds as production disruptions due to covid restrictions, contraction of factory activity in July, and an erosion of consumer demand for downstream tech-related products affect the demand for semiconductors. Consequently, prices for some chips have fallen by close to 90%. US sanctions have increasingly hindered the Chinese semiconductor industry’s ability to achieve rapid technological advancement and become self-sufficient in terms of chip demand. China’s semiconductor industry technology lags four years behind its more advanced Taiwanese and Korean peers. The CHIPS act recently approved by the US adds to the headwinds faced as it prohibits investments and development of cutting-edge chip manufacturing facilities in China by those companies subscribing to US subsidies. To add to its woes, since Jul-2022, the Chinese semiconductor industry has also been subjected to probes by the government as it is being investigated for the lack of progress and possible misappropriation of funds. Although both the US and Chinese semiconductor industries are supported by low leverage levels, increasing geopolitical risk and regulatory risk amidst an environment of overcapacity and demand declines weighs on their credit risk outlook, as suggested by the increase in the Forward PD. As the Chinese and US semiconductor industries try to navigate geopolitical turmoil amidst a demand slowdown, using CriAT’s iRAP tool, it is seen that there is an increase in the number of non-investment grade semiconductor firms within the two economies over the next 12 months (See Figure 2a). In contrast, semiconductor industries in Taiwan, Korea, and Japan, which form a major portion of the semiconductor market, continue to be supported by their long-established positions in the semiconductor value chain which potentially lend support to their stable credit outlook even in the face of demand declines.
Going forward, the challenging macroeconomic environment, overcapacity, and expectations of a recession may potentially push the cyclical semiconductor industry into a further slowdown over the coming months. With major governments across the world undertaking large investments in the industry as they work towards building their domestic production capacity, margins for large industry participants may face further downward pressure. On the demand front, though global demand for consumer products is reducing as a whole, a potential silver lining that may buoy the bottom line for the industry may be the sustained demand for semiconductors from the global automotive industry and data centers. Nevertheless, apart from the above-mentioned headwinds faced by the US and China-domiciled semiconductor companies, the robust financial profile and relatively low leverage of the global industry aids their credit risk outlook, as suggested by the Forward PD in figure 1b.
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The Forward PD estimates the credit risk of a company in a future period, which can be interpreted similarly to a forward interest rate. For example, the 6-month Forward 1-year PD is the probability that the firm defaults during the period from 6 months onwards to 18 months – this is conditional on the firm’s survival in the next 6 months. ↑
The Probability of Default implied Rating version 2.0 (PDiR2.0) provides a more familiar interpretation through mapping the NUS-CRI 1-year PDs to the S&P letter grades. The method targets S&P’s historical credit rating migration experience exhibited by its global corporate rating pool instead of relying solely on the reported default rates. ↑
Total debt to capital ratios (median) for the semiconductor industry; US - 16.53%, China - 10.42%; Profit margin (median) for the semiconductor industry; US - 11.5%, China - 11.67% Source: Bloomberg ↑
iRAP (intelligent Risk Analysis Platform) is a software developed by CriAT (https://www.criat.sg/) for conducting both firm-level and portfolio level credit analysis. iRAP utilizes the NUS-CRI Probability of Default (PD) model and links it to the live NUS-CRI database offering PDs on almost 80,000 exchange-listed corporates globally. ↑
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