Microchip: A Bottom Is Possibly In
Summary
- Management believes a bottom is in, calling a trade settlement a big "bonanza".
- Quarterly revenue has declined about 12%, in line with previous peak-to-trough declines.
- Shares trading at about 13x forward earnings after earnings compared with 5-year average of 15x.
Due to a correction in the semiconductor sector, Microchip (NASDAQ:MCHP) share price has plummeted in 2018 but has since recovered particularly well after a solid 3Q.
Management has even called out for a bottom of the cycle for the company. They said a trade resolution before March 1 would be a big "bonanza".
This is a very plausible assessment as revenue has dropped double digits from its peak but has started to gain momentum.
Data by YCharts
Quarterly revenue growth back in the 30-40% yoy range after a 12% peak-to-trough decline
Topline year-over-year growth has regained momentum even as it shoots over 5B. Apart from the global financial crisis, previous two declines were -4% and -13%. Current decline of 12% may hint at a cyclical bottom.
Source: Koyfin
Source: Company, Bloomberg estimates
Peak-to-trough revenue
Source: Company, Bloomberg estimates
Long-term margin targets have been raised and achievable
Microchip's gross and net income margins have been improving over time and exhibit low fluctuations. Management expects long-term gross margins to be between 62.5% and 63%.
Source: Company, Bloomberg estimates
Good track record of previous acquisitions bodes well for Microsemi
Having completed the acquisition of Microsemi in May 2018, the new company will be fully reflected in Microchip's results for FY2020. Given Microchip's prior acquisitions, it is expected that Microsemi will make a meaningful contribution and will build on existing operating margins. Overall, previous acquisitions recorded 5-10% boost in gross margins.
Valuations: Still Attractive
Despite the post-earnings rally, Microchip is still attractively valued at about 13x forward earnings. Given that the stock is still in growth mode and that margins are improving, I think applying a 15x historical mean to its FY2020E EPS would be appropriate.
Source: Koyfin
Source: Bloomberg
Upside remains
Applying 15x to its FY2020 consensus EPS estimate of 6.77, we get $101.6, implying about 15% upside from current levels.
Source: Koyfin
Risks
Uncertainty around macro trade.
Semiconductor industry could go through a deeper downturn.
M&A accretion fails to achieve good EPS/margin improvements.
Disclaimer: All research, figures, and interpretation are provided on a best effort basis only and may be subject to error. Any view, opinion, or analysis do not constitute as investment or trading advice, please do your own due diligence.
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