The word "microchip" has become a generic term for very small semiconductor devices. The company Microchip (NASDAQ:MCHP) specializes in microcontrollers. These tiny computers typically monitor sensors and then send output signals to other devices, but have many other uses, most notably in communications. Microchip also makes analog chips and chips that incorporate analog circuits with microcontrollers.
Microchip reported earnings on July 31, 2014, with non-GAAP EPS of $0.68, up 19% from $0.57 in the year-earlier quarter. Given that rather solid growth rate you might expect Microchip to have a P/E ratio around 25 to 30. Even after running up 2.3% to close at $46.04 on Friday, Microchip's trailing P/E was 25.4, with an estimated forward P/E of 19.7. Microchip stock has some room to rise to get in line with other companies growing revenue at a similar pace.
Revenue for the June quarter was $528.9 million, up 7% sequentially from $493.4 million, and up 14% from $462.8 million in the year-earlier quarter.
There are a number of factors underlying Microchip's growth rate, including a smart acquisition strategy. This article will focus on just two factors: 8-bit microcontroller strategy and microcontroller architecture strategy.
ARM vs. PIC
If you go back to 2012 and 2013 and listen to analysts' questions following Microchip's quarter results presentations, you will invariably hear analysts asking why Microchip is not switching to using the ARM architecture, or at least adding it as a second line of microcontrollers. The theory on Wall Street was that ARM would take over the world, leaving Microchip shareholders lying in the dust. ARM, of course, is the architecture used in most smartphones, typically coupled with the Android operating system.
ARM has been around since 1985, when it was used in some early PCs, and, like all architectures, has evolved over that time. It was little-known, other than to specialty engineers, until chips incorporating it became the backbone of smartphones. The PIC architecture was developed by General Instruments for 8-bit devices around 1975. Microchip was spun off from General Instruments in 1987.
So ARM has been available for license for microcontrollers during the entirety of Microchip's existence. Other architectures have also been used successfully for microcontrollers. The ARM-based chips found in smartphones are not microcontrollers (though the development of SoC technology, with multiple functions on a single chip, does blur the difference somewhat). Their function is more closely related to the x86 CPUs found in PCs, but with low-power draw as a major design consideration.
When an engineer chooses a chip for a socket, that engineer has several factors to consider. What is the price of the chip? Can it do what is required? And is interfacing and programming the chip easy?
Engineers want microcontrollers that are inexpensive, reliable, easy to program, and easy to place on a printed circuit board. X86 chips are typically larger, more power hungry, and more capable than ARM chips, which in turn are larger, more power hungry, and more capable computationally than PIC chips. But when circuit control is the goal, PIC chips are more capable than either X86 or ARM chips. The need for an operating system like Android, with its large memory requirements, is itself a drawback for most microcontroller applications.
Microchip's microcontrollers are all around you, working steadily. If you buy a new S Class Mercedes there are 51 chips from Microchip including about 30 PIC microcontrollers helping you. A Hyundai Genesis has 54 Microchip devices in it.
8-bit is not just a legacy product
"8-bit is adding the largest revenue growth," at the current time, according to CEO Steve Sanghi. This also defies the expectations of many analysts in the past two years. Many competitors have focused more on 16-bit and 32-bit microcontrollers, and at one point in time Microchip was criticized for not emphasizing 32-bit enough. But a 32-bit microcontroller takes up more space on a die than a 16-bit one, so they are more expensive, and also typically require more energy to operate. So for many applications 8-bit chips make more sense. With other companies abandoning 8-bit, Microchip is gaining market share and margins remain stable.
One key to Microchip's ongoing success is understanding the needs of the engineers who design devices around microcontrollers. Instead of abandoning 8-bit chips, Microchip has added features to them. This makes them more capable and easier to integrate into a wide variety of industrial and consumer devices.
As for the smartphone market, Mr. Sanghi said "We have stayed away from the smartphone market … we don't like its margins … we don't like anything about it."
It is hard to argue with 19% y/y growth in non-GAAP EPS. The only problem reported in the June quarter was too much demand. Some of the newer models of chips are so popular lead times have been extended. Microchip will accelerate its capital investments to take care of the excess demand, but inventories are expected to continue to be depleted in the September quarter.
Cash and Dividend
Microchip has $2.29 billion in cash and investments and approaching a billion in debt. It increased the quarter dividend to 35.6 cents to shareholders of record on August 21. At Friday's closing price that would represent a 3.1% yield.
Guidance for the September quarter is for non-GAAP EPS in a range of $0.70 to $0.74.
Other notable microcontroller manufacturers listed in U.S. stock markets are Atmel (NASDAQ:ATML), Freescale (NYSE:FSL), STMicroelectronics (NYSE:STM), Cypress Semiconductor (NASDCY) and Texas Instruments (NYSE:TI). But of these, only Atmel is as focused on microcontrollers as Microchip is. Atmel will be reporting Q2 results on August 6. I will be looking for how revenue and profit growth compare to Microchip.
As long as the global economy is improving, the number of microcontroller and related devices used per end product is rising, and Microchip continues to gain market share, MCHP should continue a strong ramp of revenue, profits and presumably its stock price. A global downturn would, of course, affect Microchip given that its devices are used in such a broad variety of products. Yet during the Great Recession Microchip was able to keep paying its dividend. Presuming that would be the case in the next recession, it puts a nice floor under the price of the stock. So MCHP would appear to have minimal downside with good growth potential.
Disclosure: The author is long MCHP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.