Industry Slowdown Steals The Show
This is normally one of the most exciting times of the year for the consumer electronics industry. Normally. But given the gloomy state of the industry, for those descending on the Consumer Electronics Show in Les Vegas, there doesn’t seem much to be excited about.
“I haven’t seen any major new products on the horizon,” says Ian Gilson, analyst at Zachs Equity Research. “There will be a lot of improved versions of older products, but there’s nothing exceptional. And there’s no brand new industry in its formative years that you can point at.”
Here’s a telling indicator. Logitech International—which just announced major layoffs—Cisco Systems, and Belkin are among several big-name companies that have opted not to exhibit on the show floor. Instead, they’ll be showing products in nearby hotel suites.
“Logitech is a quintessential gadget company, and they’re backing out of CES because they don’t think it’s going to be enough value for the cost,” says Andy Hargreaves, analyst at Pacific Crest Securities. “What’s going to come out of CES is that there’s not a lot of new technology for the next year or two, so companies are going to have to get really creative or cut a whole lot of costs to generate the kind of profits they have over the last few years.”
Rough Waters Ahead
CES will be something of a preview of what’s to come for the consumer electronics industry. Market research firm iSuppli forecasts a 0.8-percent decline in OEM factory revenue across the consumer electronics industry (excluding PCs, mobile phones, and GPS navigation devices).
“The economy has taken its toll both from a demand perspective and pricing,” says Sheri Greenspan, iSuppli senior analyst. “So you have a reduction in volume and a reduction in average selling prices.”
Consumer confidence is at an all-time low, and it is evident in a drop in sales of consumer discretionary products.
Or, as Gilson puts it: “I would like a new TV, but I don’t need a new TV. In today’s economic environment with unemployment and bad news, like or want has been replaced by need."
Big-ticket items such as flat-panel TVs are the most affected by the economic downturn. Greenspan notes that weakening consumer demand has led to excess inventory, which is driving prices down even further.
Along with TV manufacturers, that’s bad news for consumer electronics retailers like Best Buy . Although the company stands to gain from Circuit City’s woes, the combination of consumer weakness and a lull in the development cycle for many product categories means rough times ahead for retailers.
“Whether or not the consumer weakened, the flat-panel TV product cycle is going to end or at least significantly slow,” Hargreaves says. “The gaming product cycle is decelerating, the notebook product cycle has run its course, DVD players, GPS systems, MP3 players are all declining. From a product standpoint, they don’t have anything they can point to and say, ‘You guys have gotta’ come to the store.’”
Those same factors will affect general gadget companies like Logitech. Hargreaves notes that the company’s near-term outlook will remain weak until macroeconomic conditions improve.
“They sell very, very good products, but they’re discretionary items that are tied to platforms in decline—PCs and flat-panel TVs primarily,” he says. “It’s going to be difficult for them to generate growth when the core platforms they’re attached to are seeing a significant slowdown.”
Pockets of Strength
As tough as the current environment is, analysts say there are a few areas that will continue to see growth this year, albeit not as strong as usual. Video game hardware and software, for example, should continue to be resilient.
“It’s an excellent product when a family is trying to cut overall costs,” Greenspan says. “You can keep the family at home, the kids entertained at a reasonable price point.”
Hargreaves says gaming software companies, particularlyActivision Blizzard and Nintendo, will benefit from the growing installed base of gaming consoles. He also expects mobile Internet devices, such as smart phones and netbooks, to continue to grow. Hargreaves cites Apple as being poised to make strides in the smart phone market.
“They have the best platform in terms of the combination of hardware, operating system, and a real dynamic software ecosystem,” he says. “They’re a year or two ahead of anybody else.”
Because the consumer electronics sector is greatly affected by economic conditions, analysts don’t expect to see a recovery until the economy improves. Gilson points to historical factors in his expectation that a turnaround will occur in the second half of the year. But he notes that the market isn’t likely to move ahead of concrete evidence of a recovery.
“Most of this year has been recessionary in one way or another,” he says. “Recessions that last more than 18 months are extremely unusual. Given all of the sectors that will have to work through their problems, the market may not respond until the good news is actually apparent. They’re going to be buying on the news that there’s an actual turnaround."
For his part, Hargreaves cautions against trying to determine exactly when the situation will improve. “I think everybody is hopeful that the second half gets better, but I think that’s all it is at this point. There’s nothing that I’ve seen to suggest there’s a fundamental reason why the second half should get better.”
Andy Hargreaves does not own shares in the companies commented on. Pacific Crest Securities makes a market in the securities of Apple, Logitech, and Activision Blizzard.
Ian Gilson does not own shares in the companies commented on.