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Risky bet for techs?
Tech companies are building up inventories, citing healthy demand. But what if the economy cools?
May 14, 2004: 1:05 PM EDT
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - There are a lot of dirty "I" words causing the market to worry lately. Iraq. Inflation. And of course, in rates.

For tech investors, add this one to the list: Inventories.

Cisco Systems reported earlier this week that its inventories as of the end of its most recent quarter were up 20 percent from the previous quarter. Dell said on Thursday that its latest quarter's inventories were up 30 percent.

Last month, several big tech companies, including Intel, Texas Instruments and Lucent Technologies also reported sharp rises in inventories.

Rising inventory levels at these tech bellwethers have raised some eyebrows on Wall Street. If demand for tech cools off in the second quarter and latter half of the year, what will happen?

Demand is good now...

The memory of massive inventory write-downs following the tech meltdown in 2000 is still fresh in some investors' minds. Cisco, for example, took a $2.25 billion charge in 2001 to write off excess inventory.

"Obviously whenever inventory builds, in the back of your mind, there's always a little bit of a concern," said Patrick Ho, a semiconductor analyst with Moors and Cabot.

Part of the buildup seems to be the unavoidable result of supply shortages.

Building to excess?
Tech companies are increasing their inventories at a rate that's faster than expected sales growth.
CompanyInventory Increase (prior quarter)Est. Sales Change (current quarter)
Cisco Systems20%4.3%
Intel 11%-1.4%
Lucent Technologies14.3%0.3%
Texas Instruments16.7%9.3%
Based on sequential growth rates
Sources: Company reports, Thomson First Call

Albert Lin, director of research for American Technology Research, said some tech companies are facing a shortage of certain types of components since capital spending dropped so precipitously during the downturn.

Big tech companies like Cisco and Dell weren't faced with a great enough need for components since their large corporate customers were not buying as many computers, servers or networking equipment. Hence, components suppliers cut back on their production.

But now that demand is improving, there is a rush to purchase these components. Cisco, for example, has had to over-order some chips so it could meet expected demand for its routers and switches, Lin said.

So in some respects, tech companies are playing catch-up now that there are finally some signs of a recovery in the sector.

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"Inventory levels have been held back because of the pervasive pessimism in technology. There was resistance to build inventory because of fear of charges," said Michael Davies, a technology analyst with Investec.

Investors should also be reassured by the fact that inventories are still not approaching the levels they were at during the height of the late 90's tech bubble.

Cisco, for example, reported inventories of $1.1 billion Tuesday. In the fiscal second quarter of 2001, just before Cisco announced its write-down, the company had inventories of $2.5 billion.

Dell chief financial officer Jim Schneider admitted Thursday that his company's inventories were a bit higher than he would have liked.

But most tech companies have dismissed fears by noting that demand is picking up.

...but what about the rest of the year?

And for that reason, Michael Cohen, director of research with Pacific American Securities, said he's not spooked just yet.

"This is a sign of tech companies' optimism for the second quarter," said Cohen. "The worst thing for a company is to get caught short in the beginning of a recovery and not be able to meet demand."

Economic Indicators

Still, while few are questioning that demand is on the rise, the concern is the degree of the economic recovery and its sustainability. Ho said investors have legitimate reason to worry whether rising interest rates or higher oil prices, for example, could cause the economy, and hence corporate spending, to stall.

That's why Cohen said that it would be more important for investors to keep an eye on what happens to future inventories, as opposed to worrying about current levels.

He argues that worries about rising rates are unlikely to play a role in corporate tech spending decisions in the second quarter but that they could be a factor in the latter half of the year.

"If inventory continues to build going out a few quarters and companies that are planning for better demand don't get it, then that would be a concern," Cohen said.  Top of page

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