Seeking Alpha

Visibility For Silicon Motion

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About: Silicon Motion Technology Corporation (SIMO)
by: Jenks Jumps
Jenks Jumps
Growth at reasonable price, long-term horizon, value
Summary

When Silicon Motion reported preliminary results for the third quarter in early October, the visibility indicated full-year revenue guidance would be bolstered and the dividend bumped.

By the time the company reported actual results, both did occur. Visibility now indicates 2020 holds healthy growth potential.

Though the share price responded quite favorably to third-quarter results, the visibility indicates there's still time to invest.

When Silicon Motion Technology Corp. (SIMO) released preliminary third-quarter results on October 7th, I suspected the company would both bolster full-year revenue guidance and bump its dividend.

But I hoped the dividend increase would be announced early in 2020. Instead, that announcement was released on October 25th. I expected a 10% bump to $1.32 per ADS. Silicon Motion announced a 16.8% hike to $1.40 per ADS.

If the dividend hike announcement would have been delayed, I had hoped it would allow the company a bit more time to repurchase shares. Silicon Motion did buy $25 million of shares in the third quarter, its first purchase of the calendar year.

Based on information shared during second-quarter reporting, I had estimated Silicon Motion's full-year revenue guidance would fall in a range of $426.5-443.3 million. When the company reported actual third-quarter results on October 29th, it guided fourth-quarter revenue in a range of $133-139 million. Adding this range to the revenue of $304 million generated in the first nine months, full-year revenue is now projected in a range of $437-443 million.

The company has had a rough 2019. The clouds are beginning to clear.

(Source)

Third-Quarter Results

Silicon Motion reported revenue of $110.5 million in the third quarter. Although this was a decrease of nearly 20% compared to the third quarter of 2018, it was an 11.8% improvement compared to the second quarter of 2019. On a non-GAAP basis, third-quarter revenue was 20% greater than the 2019 second-quarter revenue. Year to date, GAAP revenue is still 25% lower in 2019 compared to 2018.

Non-GAAP net income in the third quarter improved quarter over quarter and declined year over year. Non-GAAP net income in the 2019 third quarter was $24.4 million compared to $18.6 million in the 2019 second quarter and $34.9 million in the 2018 third quarter. Year to date, net income in 2019 is 38.5% lower than in the first nine months of 2018.

During 2019 second-quarter reporting, management warned on the status of the value of its 2015 Shannon acquisition.

“A significant portion of our $34 million of goodwill and intangible assets from our Shannon acquisition is now likely impaired due to lower projected future profitability and cash flow. We are still conducting our impairment evaluation and we expect to take a large impairment charge later this year." (emphasis added)

The company completed its evaluation in the third quarter. The impairment charge equated to $15.97 million. Interestingly, the same segment of the business experienced healthy recovery in the quarter. Silicon Motion reported revenue in its SSD (solid-state drives) solutions business improved 45% quarter over quarter.

The company also explained revenue in this segment will be impacted in 2020 and beyond by a new consignment arrangement with Alibaba (BABA). Silicon Motion will no longer procure and inventory the NAND on Alibaba business. Thus, it will not be exposed to NAND price fluctuations. The repayment for the cost of the NAND will no longer register as revenue, so revenue will reflect a decline. However, gross margins in the business will improve and Silicon Motion will be assured a profit. The company has operated at break-even on Alibaba work to-date this year. Thus, in 2019, Silicon Motion was hesitant to aggressively pursue more Alibaba projects. This will change with the consignment model.

“For next year, we're willing to grow as fast as we can with Alibaba.”

When 2019 began, industry pressure was so heavy that Silicon Motion didn't offer full-year guidance.

“For full year 2019, until we receive more concrete procurement forecast from our customers, there is a reasonable likelihood that our sales revenue this year could be approximately the same as the prior year."

But nine months later, the horizon is clearing.

“Sales visibility has improved considerably since earlier this year, and based on what we are seeing from our customers’ procurement plans, our SSD controllers, eMMC+UFS controllers and SSD solutions are all expected to deliver solid growth next year.”

Importantly, the fourth-quarter projection realigns Silicon Motion's growth trend originally disrupted in the 2017 second quarter by the industry migration from 2D NAND to 3D NAND.

Silicon Motion Quarterly Revenue

(Source: Author-created from company data)

Beyond 2019

Six manufacturers dominate market share of the NAND flash memory market: Samsung (OTC:SSNLF), Toshiba (OTCPK:TOSBF), Western Digital (WDC), Micron (MU), SK Hynix (OTC:HXSCL) and Intel (INTC). In 2018, the Chinese government helped fund the entrance of Yangtze Memory Technologies into the 3D NAND market. It is expected to mass produce 64-layer 3D NAND by year-end 2019 and plans to produce 128-layer 3D NAND in 2020.

Silicon Motion's moat in the industry is its expertise in developing controllers for NAND flash makers. As each generation of NAND flash pushes for faster performance, it becomes vulnerable regarding data retention and data reliability. Silicon Motion partners with the flash makers to develop controller solutions that solve these technical issues and that are ultimately "optimized for performance, lower power, cost and ease-of-use". One of Silicon Motion's advantages is the opportunity to work with NAND flash manufacturers early in the development cycle.

“We also believe we are well positioned to increase our share of client SSD controller markets from roughly 1/3 today to 40% as we continue to increase market share as existing customers and our customers gain share in the SSD market.”

This project pipeline assists with the company's projections.

“Our pipeline of SSD controller projects with customers suggested that robust SSD controller sales growth that we are seeing this year well extends through next year.” (emphasis added)

As the leading supplier of NAND flash controllers, a growing demand for NAND flash is critical to Silicon Motion's ultimate success.

The August update to the World Fab Forecast published by SEMI forecast solid growth.

“3D NAND capacity growth will increase by 4% in 2019 and jump by double digits in 2020.”

In late September, Micron (MU) shared its outlook on the NAND industry.

“Based on our view of calendar 2020, we estimate industry bit demand growth of high 20s to low 30% range, with supply growing somewhat below demand. We expect the long-term NAND bit demand growth CAGR to be in the low 30% range.” (emphasis added)

Just last week, SK Hynix corroborated that there should be demand growth.

“In the fourth quarter... NAND bit shipment is expected to increase by around 10% level.

And then for both DRAM and NAND, it is true that there are some signs of change in demand to come.”

Share Price Action

On the news of improvement in the third quarter and an even rosier outlook for the fourth quarter and beyond, it was not surprising to see Silicon Motion's share price spark higher. After market close on the 29th, shares jumped as much as 15%. On the 30th, shares closed up 11+%. On such a move, it would appear it's too late to begin or add to an investment.

Yet, alert investors will note comments made during the earnings call. Silicon Motion mentioned returning to its 2016-2017 levels in two areas.

“But, then, looking forward, we believe our mobile [eMMC+UFS] sales revenue will go back to our highest level like at 2016 and '17 level.”

“We believe we can scale our SSD solutions business back to what we saw in 2016-'17 type levels [for gross profits].”

Silicon Motion Annual Revenue

(Source: Author-created from company data)

Profit margin in 2016 was 19.9% and 14.4% in 2017. Silicon Motion's five-year average is 17.2%. This compares to 12.8% to date in 2019. Coupling sales increases with improved margins bodes well for earnings improvement to outpace sales growth.

Silicon Motion's dividend increase may also offer some insight about potential growth on the bottom line. For years, the company's typical payout ratio fell below 40%.

Silicon Motion Payout Ratio History

(Source)

At $1.40 annually, a payout ratio at or below 40% equates to earnings at or above $3.50 per ADS. A 50% payout ratio equates to earnings per ADS of $2.80. Even a 60% payout ratio implies earnings of $2.33 per ADS, a substantial improvement over what is expected for 2019.

“With these asset impairment issues behind us and with our core SSD controller sales well positioned to continue growing robustly, our eMMC+UFS controllers making a comeback and our SSD solutions recovering and casual visibility - cash flow growth and visibility improving, our Board announced last week a new annual dividend per ADS that is 17% higher than last year's.”

Adjusting for $8.70 in cash per ADS, if Silicon Motion traded at a multiple of just 15 on earnings of $2.80 per ADS, fair value would equate to $50.70. Yet, many analysts are projecting the company's earnings will top $3.00 per ADS in 2020.

Sometimes, it's difficult to consider investing after a company's share price spikes in response to good news. But there are times when the share price has been depressed long enough that even the spike doesn't return it to fair value. Visibility seems to indicate the latter is the case for Silicon Motion.

Disclosure: I am/we are long SIMO, INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I belong to an investment club that owns shares in SIMO and INTC.