Microchip Technology Standing Out As The Cycle Turns

As the semiconductor boom rolls over, product and market exposure matters more, and that should benefit Microchip (NASDAQ:MCHP) at least to some extent. While the company doesn't have the high-end data center or auto exposure that I believe will serve companies like Broadcom (AVGO), Marvell (MRVL), or onsemi (ON) better over the next 12 months, Microchip does at least have limited exposure to weakening consumer markets, as well as stronger exposure to capacity-constrained specialized components like MCUs and FPGAs.

Microchip shares are down since my last update, but have nevertheless meaningfully outperformed the broader SOX index. Given the outperformance and the market/product mix, I find Microchip more of a "middle option" between beaten-down names with more near-term vulnerability (like companies with high smartphone exposure) and companies with stronger near-term leverage in the data center or EVs (Broadcom, et al). I like what I see as double-digit long-term annualized return potential from here, though, and the valuation makes this a name to consider now.

 

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Microchip Technology Standing Out As The Cycle Turns

Microchip Technology Shifting Toward A Lucrative, Sustainable Model, But Sentiment Is A Real Concern

 

Writing about Microchip Technology (NASDAQ:MCHP) a year ago, I was concerned more about the eventual shift in investor sentiment on semiconductor stocks than any fundamental issues with Microchip. Indeed, while Microchip continues to execute at a high level, the shares have lagged the SOX since that last update, and I do still see some risk to sell-side estimates as industry capacity eventually catches up to still-hot demand.

I like Microchip's strategic shift to a focus on leveraging its broad capabilities across a range of markets, a move that should drive better sustainable margins and stronger cash returns to shareholders. What I don't like as much is the relatively more modest leverage to faster-growing sub-markets, as well as the sour market sentiment on this sector. Mid-to-high single-digit revenue and FCF growth can support a decent high single-digit long-term return here, but there are cheaper names with better leverage to end-markets I like better.

 

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Microchip Technology Shifting Toward A Lucrative, Sustainable Model, But Sentiment Is A Real Concern

Microchip Technology Trying To Manage Unprecedented Near-Term Demand Ahead Of Attractive Long-Term Growth Opportunities

These are crazy days in the chip space, with semiconductor companies struggling to secure the wafer, assembly, and test capacity they need and strong demand pushing lead times to new peaks. Supply constraints are likely to lead to a longer period of sustained high lead times than past cycles, but achieving a graceful dismount will be an industry-wide challenge.

Luckily, in the case of Microchip (MCHP) at least, there are strong underlying end-market drivers that can help patch over some of the likely oncoming volatility.

Microchip wasn't a favored name of mine when I last wrote about the stock in August, though "only" matching the SOX was still good for a nearly 40% move in the stock. As for the stocks I liked better, Lattice (LSCC), ON Semiconductor (ON), and Renesas (OTCPK:RNECY) have outperformed, Broadcom (NASDAQ:AVGO) has basically matched Microchip, and STMicroelectronics (STM) has underperformed.

Looking out at the sector now, valuations are stretched and it's hard for me to see how multiples rerate higher, particularly with revenue outperformance like constrained by supply/capacity issues. At best, I can see the order/lead-time situation leading to an extended peak, but the multiples across the space today are tough to embrace.

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Microchip Technology Trying To Manage Unprecedented Near-Term Demand Ahead Of Attractive Long-Term Growth Opportunities

Microchip Technology Already Trading On The Recovery-To-Be

Investors have been seemingly chomping at the bit all year to buy a semiconductor rebound that has yet to happen. Of course investors look to get early (the market is a discounting mechanism, after all), but it seems like "oh, next quarter it will turn around" is all that investors have needed to hear. To that end, while my relative value call that Microchip Technology (MCHP) wasn't a great candidate to buy back in May has mostly worked out - the SOX has outperformed by about 10% and my favored name, STMicro (STM), has outperformed by much more - the shares are still up almost 15% from that last article (beating the market).

Although Microchip's business is finally turning (after six consecutive quarters of downward guidance revisions), and this is a very profitable and very diverse chip company, I can't say I love the valuation. Anticipatory buying has already taken a lot of semiconductor share prices higher, leaving investors to either rationalize higher fair values, accept lower returns, or cast about amongst the more troubled stories.

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Microchip Technology Already Trading On The Recovery-To-Be

Microchip Technology Bumps Along The Bottom

I’ve been writing for a little while now that I thought the semiconductor rally was ahead of itself, and that between ambitious expectations for a second half bounce, high inventories, shrinking lead-times, and ongoing uncertainty with trade relations with China, there were a lot of factors in play that could blunt the “V-shaped” rally so many investors seemed to be counting on. To that end, I thought Microchip Technology (MCHP) shares were ahead of themselves in the short term back in February, and the shares are now pretty much flat versus that last article.

With Microchip revising down for the fourth time, and blaming it largely on the tariff issue, I wonder if this will be the moment of reckoning for the larger chip space. Either way, I still see some downside risk over the near term. Specific to Microchip, I do like the business and management’s active approach to inventory management and M&A, even if I think they are occasionally too bullish on guidance. High debt is a risk (almost 8x my FY20 FCF estimate), and the shares don’t look like a margin bargain on short-term metrics, but I’d keep an eye on any sell-off, as I think the shares can go higher over the long term.

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Microchip Technology Bumps Along The Bottom

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

Silicon Labs Well-Placed For Long-Term Growth, But The Short-Term Could Get Rocky

With both fundamentals and sentiment in and around the semiconductor sector noticeably cooling, valuations are getting more reasonable and attractive on a long-term basis, but the correction process still has some distance to go. In an environment where GDP growth seems likely to slow, Silicon Labs (SLAB) could well be looking at a period where the improvements in the business go largely unrewarded by the market until institutional investors feel comfortable moving back into semiconductor growth stories.

I didn’t think Silicon Labs was attractively priced for a “buy” back in August, and the shares are down another 20% or so since then (slightly underperforming the SOX). I still don’t consider today’s price a slam dunk, but I do believe the company is making progress and becoming better-positioned for future growth in multiple end-markets. A price in the low $70’s would be more interesting to me, but I’m hesitant to dive into chip stocks today given the prospect for worsening outlooks for autos and industrial markets and the risk of at least another round or two (if not more) of cuts to expectations.

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Silicon Labs Well-Placed For Long-Term Growth, But The Short-Term Could Get Rocky

Microsemi Finds Its Last Deal

Management at Microsemi (MSCC) is known for commenting that in semiconductor M&A, "You buy until you get bought." There have been rumors off and on about potential bidders circling Microsemi for a little while now, and the executive management's compensation plan was certainly structured to reward a deal. Now Microsemi finally found its buyer - Microchip Technology (MCHP), a seasoned semiconductor M&A veteran that should reap meaningful revenue and cost synergies from the deal.

Given the deal price, I don't think Microsemi investors have a compelling need to stay to the very end; a rival bid is always possible, but the price offered isn't such that I think another bid is highly likely. Pre-market indications are that Microsemi won't trade up to the full bid price just yet, though, so Microsemi investors can at least get paid a little for waiting unless and until they have a better idea.

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Microsemi Finds Its Last Deal

Silicon Labs' IoT Energizer Bunny Keeps Going

Silicon Labs (SLAB) continues to leverage its opportunities in the fast-growing IoT market, and that continues to drive good revenue and profit growth for this relatively small semiconductor stock. Silicon Labs has moved aggressively, largely through M&A, to acquire a strong portfolio in wireless (especially mesh networking and connectivity) technologies, giving it a strong position in home/consumer IoT and allowing it to "punch above its weight" relative to some of its much larger rivals.

While I continue to expect good things for SLAB's IoT business, and I believe the Infrastructure business can leverage growth in optical and 5G deployments, the valuation is not forgiving. Growth and momentum investors likely won't care about the valuation, but with the stock trading at close to five times forward revenue, it may be challenging for the company to grow fast enough to substantially expand that multiple.

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Silicon Labs' IoT Energizer Bunny Keeps Going

Strong Execution On IoT Is Taking Silicon Labs To A New Level

Chip company Silicon Labs (NASDAQ:SLAB) was already doing pretty well with its Internet of Things (or IoT) business back in the summer of 2016, but I underestimated the company's ability to continue to leverage that driver. As IoT is becoming an increasingly real driver, it is having a solidly positive influence on Silicon Labs' performance, and the shares are now about 40% higher than when I last wrote on the company.

Silicon Labs isn't going to have the IoT opportunity all to itself; Qualcomm (NASDAQ:QCOM) (through NXP Semiconductors (NASDAQ:NXPI)), Microchip (NASDAQ:MCHP), Texas Instruments (NYSE:TXN), and STMicroelectronics (NYSE:STM) among others are going to be competing fiercely in this growing market. Silicon Labs' strong positioning across the range of connectivity options and in mesh networking are important drivers, but other rivals have their own areas of strength in MCUs, security, sensing, and so on. What's more, the valuation is now considerably more demanding, and with it come much higher expectations for the lead IoT and Infrastructure businesses.

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Strong Execution On IoT Is Taking Silicon Labs To A New Level

Gemalto In A Bruising Transition Period

It has been a while since I've written on Franco-Dutch digital security company Gemalto (OTCPK:GTOMY) (GTO.PA) (GTO.AS). I thought the shares looked interesting back in February of 2013 on the potential to benefit from growing 3G/4G adoption and the conversion to EMV chip cards, and the shares did alright in the following two years (albeit with volatility). Starting around mid-2015, though, circumstances changed dramatically for the worse in the company's mobile SIM card business, and recent pressures from the payment/EMV business have made things worse.

I believe the company, and the shares, are in a tough transition period. I don't think mobile SIM cards will ever be a driver for the business, and I'm not sold on the prospects for mobile payments and contactless EMV cards to drive meaningful long-term value. I do believe, though, that the company's position in security platform/services, enterprise security, government, and machine-to-machine can drive worthwhile growth in the years to come.

The shares do look undervalued today on the basis of revenue growth in the neighborhood of 4-5% and FCF growth around 7-9%. That said, for those who can stomach the risk of missing out, waiting a little longer to make sure there isn't another shoe to drop may be a better decision in terms of long-term risk/reward. In terms of the mechanics of buying the shares, the U.S. ADRs do trade, but there is better liquidity in the European markets and most brokers now handle these trades at reasonable prices.

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Gemalto In A Bruising Transition Period

Seeking Alpha: With The Pullback, Silicon Labs' IoT Opportunity Looks More Interesting

There aren't many sectors doing especially well right now in the stock market, so the pullback in semiconductor stocks isn't exactly surprising, let alone unique. As about a quarter of the industry's revenue comes from industrial markets, and meaningful amounts come from computing, consumer devices, and phones, it is not so surprising that investors are worried about the outlook for 2016 even though multiple semiconductor CEOs have opined that the slowdown will be briefer and shallower than past downturns.

This brings me to Silicon Labs (NASDAQ:SLAB). The shares of this microcontroller, sensor, and RF chip company have fallen around 15% since my last update, more or less matching the decline in Microchip Technology (NASDAQ:MCHP) and outperforming NXP Semiconductors (NASDAQ:NXPI) over that period. While the company has definitely had some challenges with more commoditized competition in segments like TV tuners, the company's Internet of Things (IoT) business continues to grow nicely.

Valuation is still mixed, though the shares are now below both my cash flow and margin/revenue-based fair values. IoT is still a somewhat sexy topic in the chip space, and the company's combination of MCU/sensor/RF capabilities and relatively high operating expenses (fueled by aggressive R&D spending) could generate some potential M&A interest. Although there are other chip companies I like better (including Microchip and Microsemi (NASDAQ:MSCC)), I won't pretend that Silicon Labs is trading at a more attractive level if you believe in the long-term potential of IoT applications.

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With The Pullback, Silicon Labs' IoT Opportunity Looks More Interesting

Seeking Alpha: Microchip Technology And Atmel The Right Match

It's been a while since I've written on Microchip Technology (NASDAQ:MCHP), mostly because I have thought this well-run MCU and analog chip company was pretty fairly priced in the market and didn't offer all that much opportunity. While some in the peanut gallery didn't like it when I last wrote in May of 2014 that I preferred Atmel (NASDAQ:ATML) (a smaller, less well-run MCU player), Microchip is down about 14% over that period while Atmel has fallen less than 4%.

Now these two players are looking to tie themselves together permanently. Although I've thought for a while that Atmel could be a M&A target, I was surprised to see Dialog (OTC:DLGNF) step up given the questionable synergies. Dialog shareholders weren't too pleased either, and the erosion in value of Dialog shares kept a window of opportunity open for Microchip. Together, Microchip and Atmel will be the #3 MCU company in the world (trailing Renesas (OTCPK:RNECY) and NXP Semicondcutors (NASDAQ:NXPI) after its deal for Freescale), and Microchip will have a very fertile opportunity to drive margin synergies.

While the merger is not a done deal (so there is risk to deal closure), I believe Microchip's fair value climbs into the low $50's with Atmel in hand. Buying any stock feels like a bold move right now, but I believe Microchip has a strong record of driving cost savings from acquired properties (a primary driver of value in this deal) and a strong record of overall operating execution.

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Microchip Technology And Atmel The Right Match

Seeking Alpha: Softer Markets And Weak Execution Are An Ugly Mix For Atmel

I wasn't overly fond of Atmel's (NASDAQ:ATML) valuation back in March, but I did think there was a chance that this chip company would see itself swept up in the M&A boomlet across the chip industry. The market thought so too, taking the shares up almost 20% at the peak after my last article. Then harsh reality started to set in, as markets like computing, handsets, and general industrial started looking weaker and weaker. All told, the shares sit about 6% lower than where they were at the time of that last writing, but now sentiment is definitely more sour - on chips in general and Atmel's execution/guidance issues in particular.

I still think that a sale of the company is a distinct possibility. The company's microcontroller business represents a relatively scarce asset that could appeal to companies ranging from Analog Devices (NASDAQ:ADI) to Microchip (NASDAQ:MCHP) to Texas Instruments (NASDAQ:TXN), with Avago (NASDAQ:AVGO) and Qualcomm (NASDAQ:QCOM) as potential long-shot bidders as well. If the company doesn't sell, better execution is an absolute must and likely to be the first priority for the new (and as of yet unannounced) CEO. Atmel does have a legitimate opportunity in front of it with increasing chip content in autos and the growth of Internet of Things (or IoT) applications, but past foibles make it an entirely legitimate question as to if the company can actually deliver on the potential.

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Softer Markets And Weak Execution Are An Ugly Mix For Atmel

Seeking Alpha: Can More Be Squeezed From Microchip Technology In This Cycle?

I'll state off the top that I like Microchip Technology (MCHP) as a company. The company has established itself as a top five player in microcontrollers (or MCUs) and is poised to benefit from the growing Internet of Things (or IoT) opportunity, as the company offers strong complementary technologies in MCUs, analog, and connectivity. The downside is valuation, where I just don't see as much upside potential and would prefer Atmel (ATML) on a head-to-head basis.

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Can More Be Squeezed From Microchip Technology In This Cycle?

Seeking Alpha: Atmel Now An Execution Story

Opportunity is not the problem for Atmel (ATML). There are multiple growth avenues for the company's large microcontroller business, not the least of which is the Internet of Things (or IoT) opportunity. There is also still an opportunity for Atmel to make good on the potential of XSense, participate in auto market growth, and continue to wring cash from its memory business.

The problem is execution. The company's touch business, and XSense in particular, haven't developed as hoped and the company has more of a recent history of promising rather than delivering. The potential is there to take this stock to $10 (or higher), and management compensation appears aligned with investor interests, but Wall Street seems to be sliding into a "show me" skepticism with this company and this stock.

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Atmel Now An Execution Story

Investopedia: The Recovery Proving Slow To Arrive For Analog Devices

Since Analog Devices (NYSE:ADI) reports off the normal calendar cycle, the company's earnings reports can serve as a sort of “mid-quarter” update on the analog sector. To that end, what Analog Devices had to say wasn't terribly encouraging. While there are seasonal recoveries underway in the industrial and auto sectors, signs of a big recovery are still lacking. With many players in the analog sector already having traded up on recovery expectations, value investors may find this stock a little lacking in appeal.

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Investopedia: Analog Devices Marking Time Until The Rebound

Apart from a few signs of life in the telecom infrastructure space, there hasn't been much to cheer about for semiconductor stock investors lately. Consumer electronics are still pretty weak, auto build rates have slowed noticeably and industrial demand has swooned on macro/fiscal worries for 2013. All in all, Analog Devices (Nasdaq:ADI) did OK for its fiscal fourth quarter, but the reality is that these quarters are basically "filler" ahead of the next rebound.

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Investopedia: Analog Devices Gearing Up For The Rebound

There was ample investor enthusiasm for semiconductor stocks to start the year, but that love has cooled a bit lately. While Analog Devices' (NYSE:ADI) slightly cautious guidance on the next quarter may spook some investors, there's a more important story to keep in mind. Analog Devices has shown remarkable margin preservation through this latest downturn, and the company may be in place to deliver some truly incredible gross margins once orders and utilizations have come back up to speed.

A Somewhat Wobbly Quarter  
Analog Devices delivered results around the low end of its prior guidance range. Revenue dropped 10% on a sequential basis and a similar amount on a year-over-year basis. Consumer spending was especially weak (down 21%) and wireless was quite soft as well (down 13%). While industrial was still negative (down 3%), auto was positive (up 6%).

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Investopedia: Linear Breaks Formation

It looks like the third week of January is when a little good news came back into the semiconductor world. Though Altera (Nasdaq:ALTR) and Texas Instruments (NYSE:TXN) previously suggested the worst was about to be over, ironically while lowering guidance for the fourth calendar quarter, equipment vendor ASML (Nasdaq:ASML) and analog chip company Linear Technology (Nasdaq:LLTC) gave outright encouraging news with their respective quarterly reports.

Results Still Not Exactly Pretty  
To be sure, enthusiasm about the Linear story is about what's going to happen and not about what did happen. Results in the company's fiscal second quarter weren't that great, as revenue dropped 11% on a sequential basis and 23% on a year-on-year comparison. The revenue shortfall was largely just a byproduct of ongoing industry de-stocking throughout industrial, communications, auto and other markets.


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