The supply chain shortage has not seen any relief in 2021, particularly when it entered the third-quarter traditional electronic peak season. Market demand has increased, but overall production capacity has not.
Although an uneven gap in component supply has emerged, the inventory for some components has significantly increased; however, the key wafer foundry production capacity for mature processes such as 28nm cannot be increased.
The real shortage is with the semiconductor chip supply, which is stuck and not easy to quickly resolve. In fact, the overall supply chain shortage is getting worse and increasingly serious instead of better.
The COVID-19 pandemic resulted in a lot of early material preparation, starting at the end of 2020. At the time, I was not concerned about the material shortage, but now most of the prepared materials have already been used.
From the terminal application perspective, the most serious material shortage in the first quarter was in notebooks (NB). In the second quarter, it was in the network communications field. Now, the material shortage for car use in the third quarter has led to a huge suspension in production. Additionally, finding materials in the third quarter has been especially difficult.
In order to guarantee the stable and steady supply of goods and early signing of long-term contracts, upstream suppliers should prepare to expand their production capacity sooner. This wave of semiconductor chip shortage is expected to ease in the second half of 2022.
The surge in NB purchases brought on by the stay-at-home economy is expected to continue, as the demand for hybrid offices as a result of the new normal established during the pandemic will continue into 2022.
Pandemic continues in Southeast Asia, as benefits of deferred demand remain to be seen
Our original goal was to control the material gap within 5%. Currently, it may still exceed this range, but we are working hard to narrow the supply gap.
Yet, it has also been observed that the material shortage has become so serious that some automakers have had to suspend production. Will the outlook for the second half of the year be revised downward because of the shortage? For now, it remains to be seen; however, the third quarter will outperform the second quarter, but may not be as optimistic as initially expected.
In the past, operating peaks were mostly in the third quarter. But due to the material shortage, the peak in 2021 will likely be in the fourth quarter. This is mainly attributed to two factors. First, the shortage has caused purchase order shipments and demand to be deferred. Second, the lunar new year holiday will fall at the end of January 2022. In order to prevent labor and material shortages, downstream clients will prepare extra materials one month in advance, which will be the fourth quarter of 2021. This could cause what is usually a slow quarter to not be so slow in 2021.
The car-use market, which had the highest market expectations, suffered client short-term order revisions due to the material shortage and sudden resurgence of the pandemic in Southeast Asia (SEA) in the second half of the year. The shortage of goods in the third quarter worsened, and to some extent is linked to the pandemic in SEA.
The tight supply in back-end packaging and testing in Malaysia and the shortage of microcontroller units (MCU) has caused a mutual squeeze out. Production capacity may only be 30% to 40% and goods are facing a bottleneck at the ports. The shortage in the second half of this year is expected to last until 2022.
Although demand in the second half of the year is expected to be deferred, relevant production capacity will likely be restored once the pandemic has eased, which is expected to occur in the fourth quarter, but we cannot rule out the possibility of other external factors slowing market demand. Even though this should reduce the deferral rate in the fourth quarter, we should still remain cautious. We should not be overly optimistic that third-quarter demand will be delayed until the fourth quarter to avoid having material inventories that are too high.
The material shortage will likely impact revenue, but our view on profit growth has not changed. Furthermore, the material shortage may increase gross profit margin since we will allocate resources to higher-profit products and actively carry out product optimization.
Even though utilization rates may decrease, labor recruitment costs will also decrease; labor costs are especially higher when market conditions are good. Due to the material and labor shortage, operations will revise their resource allocation and will no longer pursue revenue growth. Instead, gross profit margin growth will be greater than revenue growth.
In regard to the outlook for the second half of the year, it remains unchanged from our original target. If the material situation improves, the biggest benefit will be in production capacity. It could drive the opportunity for continued gross profit margin to grow.
Optoelectronics and cloud applications grow steadily, future growth for car use is promising
Despite the overall uncertainty, the growth potential of optoelectronics and cloud product applications in the second half of the year is expected to exceed double digits. In fact, the B/B value of optoelectronics is expected to be 1.7 to 1.8 times that of the first half of 2021. Although there is a decrease compared to the first half of the year, it is still at a high level. The main drivers lay in the strong demand for optical couplers and optoelectronic semiconductors products. As a result, there was a 20% to 30% increase in price in February/March 2021. At that time it was believed that overbooking in the market was the cause. Looking at it now, it is confirmed that there was overbooking. The market returned to being rational during the second and third quarters.
As for the infrared (IR), production capacity expanded by 50% in 2021. Even though production capacity has expanded, IR supply is still tight.
In terms of cloud, growth came from new products entering mass production in the second half of the year. This may cause the growth rate to exceed the market average.
Although the server industry was also impacted by the material shortage in the second quarter, the material shortage for cloud applications was controlled. Instead, recently the material shortage in the car-use market has suffered the most.
Lite-On bets on growth in car light market
In addition, we expect huge growth in the car light market in the future. Growth will come from Lite-On's industry supply status rising from Level 1 to Level 2 or 3. From the end customer perspective, in the past, they took care of car light thermal modules themselves. However, with resources changing with the development of smart headlight applications, now Level 1 to Level 3 must all outsource.
So-called Level 1 is a single motherboard and Level 2 is with a thermal module, which can increase the average selling price (ASP) by 30%. Once you get to Level 3 it is a complete semi-finished product, which further increases the product's added value.
In 2021, the estimated revenue scope from car-use products is expected to exceed NT$10 billion, accounting for around 7% of overall revenue. This includes car lighting/car lights, car lenses/optics components, car power supply, and internal parts in-car dashboards. This number is expected to reach up to 15% in 2023.
In regard to setting up factories and investment in SEA, we are setting up factories in Thailand and Vietnam. The former will focus on optoelectronic products and the latter will focus on network communications and consumer products.
The factory in Thailand was hit hard by the pandemic in May and June. Although production was not suspended, there was still a shortage of manpower due to some employees being in isolation and a shortage of rapid COVID-19 tests. The factory is currently operating normally.
In Vietnam, the pandemic was most severe in the south in Ho Chi Minh City. Lite-On's Vietnam factory is situated in the northern region, and materials are prepared and transported from China, not procured locally. As a result, the impact was limited.
Phase 2 of the Vietnam factory expansion is still in the discussion phase. We expect to begin construction in 2022. Completion and start of operations are expected in 2023. Routers and switches originally produced in China can be moved to the Vietnam factory, with taxes and production costs being the main reasons for the shift.
On the software side, we plan to establish a software research and development (R&D) center in southern Taiwan in the second half of 2021. The investment will focus on the development of software for car-use electronics, cloud, and 5G.
We also plan to strengthen our R&D investment. R&D expenditure from revenue originally accounted for 3% and will increase to 4% to 5%. We will work together with manufacturers to jointly expand our market share.
(Editor Note: Anson Chiu joined Lite-On in 1987. He has served as head of procurement and head of the PC/NB business unit. While working in the US subsidiary of Lite-On he was responsible for expanding the cloud computing business. In 2016, Chiu was appointed general manager of the power conversion business group. In 2018 he was promoted to CEO of the power conversion business group, as well as becoming responsible for the Internet of Things business unit in 2020. In July 2020, Chiu was promoted to CEO of Lite-On Technology.)