Execution, Opportunity, And Scarcity Value All Propelling Lattice Semiconductor

Lattice Semiconductor (LSCC) remains a case-in-point as to why I recommend investors not worry about valuation quite as much when they already own a growth company that is executing well – when growth investors lock onto a name, they can propel the valuation to and beyond levels that seem well out of proportion to the underlying operational story.

That’s not meant as sour grapes with respect to Lattice, though of course I wish I’d bought shares at literally any price over the last few years. I see significant growth potential in the company’s low-power FPGA target market, and that opportunity is matched by what I believe has been good execution from this management team. The issue for me is that the shares already trade at over 50x 2021 EPS and 12x 2021 revenue. Even allowing for beat-and-raise opportunity, I just don’t know how to reconcile that valuation, particularly with the shares already trading at more than 100% of management’s prior estimate of its 2022 served addressable market.

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Execution, Opportunity, And Scarcity Value All Propelling Lattice Semiconductor

Lattice's Investor Day Highlights The Separation From The Company's Past

To the extent that a bullish position on Lattice Semiconductor (LSCC) is controversial, at least beyond valuation arguments, it is controversial primarily because Lattice used to be a poorly-run, scattered, low-value-add chipmaker. I’ve written multiple articles on how Lattice has changed (new management, new plan, new priorities, et al), but the company made its own case recently with an Analyst Day that highlighted what’s new and different about Lattice today.

For those who’ve been following the story closely over the last year or so, this Analyst Day was more evolutionary than revolutionary, but management nevertheless provided some interesting detail, particularly with respect to content opportunities, a new design philosophy, and the near-to-medium-term financial model. It wasn’t a home run presentation (there was some disappointment on the operating margin target), but it was a positive in my view and this is still a stock that interests me at the right price.

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Lattice's Investor Day Highlights The Separation From The Company's Past

Lattice Semiconductor On The Run As Investors Start To Appreciate The New Opportunities

I’ve been pretty bullish on Lattice Semiconductor (LSCC) for a while now, as I’ve thought that this company has some really interesting opportunities in low-power FPGAs, and particularly given the strong management team the company has assembled. In addition to diversified growth opportunities across autos, industrial (machine vision, security, et al), communications, and data center, Lattice is an under-appreciated player in low-power AI inference, a high-potential market only just getting started.

Clearly the word is out on Lattice now, as the shares reacted very positively to first quarter guidance that was quite a bit better than what most chip companies have offered. While I’m worried about talking myself into a more bullish to support a higher fair value, I really do think there’s something here and that these are still the early innings of what could become an impressive differentiated chip growth story.

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Lattice Semiconductor On The Run As Investors Start To Appreciate The New Opportunities

Lattice Still Looks Like A Very Interesting Self-Improvement Story

Conditions have gotten ugly in the semiconductor space but not equally so for all players. Companies in the field-programmable gate array (or FPGA) space have held up better, as both Lattice (LSCC) and Xilinx (XLNX) are up about 15% over the past year, well ahead of the 12% decline in the SOX, and both are likewise well ahead of the SOX on a six-month comparison (where Xilinx has significantly outperformed Lattice). Although Lattice offered a very weak guide for the fourth quarter as distributors burn off inventory and Asian customers order less on macro uncertainties, much of that post-earnings drop has been recovered in recent weeks.

I really like the Lattice story. There is scarcity value in the FPGA space overall, and I think Lattice has a meaningful opportunity in focusing on "lower horsepower" FPGAs where Xilinx and Intel (INTC) really don't compete and where Microchip (MCHP) may well not be as focused as Microsemi was. I also believe there is a significant longer-term margin improvement opportunity here, and one that management seems to take quite seriously. The only "but" is valuation; Lattice does look a little undervalued and there is an opportunity for upgraded expectations over time, but it screens out as relatively fairly-valued in a space with a lot of cheaper-looking alternatives.

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Lattice Still Looks Like A Very Interesting Self-Improvement Story

Increased Focus On Better Margins Driving More Value At Lattice Semiconductor

Lattice Semiconductor (LSCC) has been doing alright. Up about 20% since my last update and up close to 40% over the last year, Lattice has not only outperformed the SOX by a good margin but also a number of high-quality chip names like Silicon Labs (SLAB) and FPGA competitor Xilinx (XLNX). Some of this outperformance is due, I believe, to management simply stabilizing the business in the wake of the collapse of the Canyon Bridge deal, the deterioration of the Silicon Image business, and challenges in the mobile/consumer business. More recently, though, management has taken more definitive steps toward enhancing the margin profile of this business, and as margins are a prime (if not principal) driver of semiconductor stock valuation, this enhanced margin focus has upgraded the value proposition at Lattice.

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Increased Focus On Better Margins Driving More Value At Lattice Semiconductor