Microchip Trading More Reasonably, And With Future Margin Leverage

Quality has never been my issue with Microchip (MCHP). I like this leading player in microcontrollers (or MCUs), but valuation has often been more difficult for me. Since my last update, though, the shares have underperformed the chip sector by about 10% and the valuation is a little more appealing. Microchip certainly has elevated debt, but I expect the company to continue generating robust cash flow and I like the company’s market exposures on balance.

Microchip isn’t a clear-cut bargain, but then I wouldn’t expect that with a company that has leading share in some tough-to-crack markets (like MCUs). I’m more interested in the valuations of chip companies more leveraged to power (namely STMicro (STM) and Infineon (OTCQX:IFNNY)), but as a quality MCU and analog play, Microchip is at least worth monitoring.

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Microchip Trading More Reasonably, And With Future Margin Leverage

Microchip Called The Bottom... But What Will The Bounce Look Like?

Microchip’s (MCHP) CEO Stephen Sanghi has never been what you might call shy or retiring, but his call for the March quarter being the bottom of this cycle still got plenty of attention. In the case of Microchip, it may well be true, though there are caveats related to trade talks between the U.S. and China and not so much certainty on what the shape of the post-bottom bounce is going to look like.

I liked Microchip back in mid-September and the 10%-plus return since then has meaningfully outperformed semiconductors in general, as well as more MCHP-relevant comps like STMicroelectronics (STM), Infineon (OTCQX:IFNNY), Texas Instruments (TXN), and NXP (NXPI). While I do think there are still attractive revenue and margin drivers in play here, I’m not quite as bullish as I was before and I think there are other names to consider in the MCU/analog/FPGA space.

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Microchip Called The Bottom... But What Will The Bounce Look Like?

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

Microchip Looks Undervalued, But There Are Short-Term Challenges To Consider

Buying good companies on stumbles is a time-tested strategy, but one that stills carries risk – it’s not always easy to separate a stumble from a prolonged tumble down the stairs. In the case of Microchip (MCHP), while issues related to its recent Microsemi purchase loom larger in the short term, I’m a little more concerned about the potential impact of extended lead times and weakening demand in important end-markets.

I believe Microchip has proven itself to be a well-run chip company, and I like the company’s diverse capabilities across microcontrollers (or MCUs) and analog, as well as the new opportunities brought in with the Microsemi deal (including FPGAs, timing products, data center products, and so on). Although this may not be the ideal time to buy given sentiment toward the semiconductor space, the long-term value proposition makes this a name worth considering for more value-driven investors.

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Microchip Looks Undervalued, But There Are Short-Term Challenges To Consider