- Microchip’s revenue will grow significantly in the long term driven by its FPGA and microcontroller solutions.
- The company is rapidly paying off its debt, which is driving the demand for its shares, and its share price is rising.
- Long-term investors can accumulate the company’s shares gradually utilizing proper pullbacks.
Microchip Technology (NASDAQ:MCHP) is a medium-growth semiconductor company with significant growth opportunities in the long run. I expect the company’s revenue will grow at a CAGR of high single-digits in the next five years driven by increasing demand for its FPGA and microcontroller products. The company will be able to grow its dividend payment as well due to its sustainable revenue growth and consistent debt reduction. The demand for the company’s shares will increase significantly in the coming years driven by its growth prospects, which will result in meaningful share price appreciation. Long-term growth-oriented investors can buy Microchip’s shares during pullbacks to maximize their gain.
Microchip offers its customers embedded control systems primarily consisting of microcontrollers. The company also offers easy-to-use development tools which allows its customers to create technologically advanced products. The company’s portfolio of semiconductor products is capable of reducing total system cost and time to market. The company serves the following end markets: industrial, datacenter and computing, automotive, communication, consumer, and aerospace and defense.
Microchip’s FPGA product family is its primary growth driver. The company’s FPGAs (field programmable gate arrays) help OEMs (original equipment manufacturers) reduce system level energy consumption, make their products safer to operate, and add security to their products. That’s why the company’s FPGAs beat many of its competitor products. Modern FPGAs are built keeping in view an advantage over ASICs (application specific integrated circuits), which is the flexibility related to design change and scope of computation even at a later stage of product development. Due to this advantage, FPGAs will be preferred in increasing number of industries in the coming years, which will be responsible for Microchip’s FPGA revenue growth in the coming years. This will boost the company’s overall revenue growth in the long term.
Microchip offers a wide array of general purpose microcontroller products to its customers. The company’s microcontroller product family is its another growth driver. These microcontroller products enjoy strong demand in the worldwide microcontroller market because they are designed to provide expanded functionality and superior performance characteristics compared to competitor products. In addition, Microchip's microcontrollers cover a vast majority of applications, such as communications, computing, automotive, industrial, and power supplies, and as a result, the company has established itself as a market leader in the microcontroller market. This is another reason for strong demand for the company’s microcontrollers. From the macro point of view, growing demand for industrial automation, strong IoT (Internet of Things) demand, and the advent of smart grids are driving the worldwide demand for microcontrollers, which are conducive to Microchip’s expanded revenue growth in the long term.
Microchip operates in a highly competitive industry with several competitors. Its competitors include Analog Devices (ADI), Infineon Technologies (OTCQX:IFNNY), STMicroelectronics (STM), Xilinx (XLNX), ON Semiconductor (ON), and Silicon Laboratories (SLAB). Microchip competes with these players on the basis of product quality and performance, product ease of use, customer support, and price.
Microchip’s primary competitive advantage is that it offers its customers Total System Solution (TSS), which is a combination of hardware, software and services. TSS helps the company’s customers increase revenues, reduce costs and manage risks in a better way compared to competitive solutions, which in turn ensures the company’s long-term revenue growth remains sustainable. The company's another competitive advantage is that it is capable of offering synergistic products (ensuring rising demand for the products) to its customers in the fields of AI (artificial intelligence) and machine learning, datacenter, IoT, 5G communications, and ADAS (advanced driver assist systems), which allows them to achieve significant cost reduction resulting in strong bottom-line growth in their respective businesses. Many of these fields are new for the semiconductor industry with immense growth opportunities for Microchip.
Second Quarter Fiscal Year 2022 Results
Microchip delivered second quarter fiscal year 2022 net sales of $1.65 billion, up 5% sequentially and 26% year-over-year. The company’s non-GAAP net income was $605.6 million, up 45% year-over-year. The company’s cash flow from operations came in at $611.7 million and free cash flow was $533.2 million. The company paid down $415.6 million of debt in the quarter.
The company delivered excellent top-line and bottom-line growth. Top-line increased driven by microcontroller and analog revenue growth. Microcontroller revenue was up 27.1% year-over-year, and analog revenue was up 35.8% year-over-year. Bottom-line increased driven by scale and acquisition synergies. The company pays steady dividends, which is another reason I like Microchip stock, apart from revenue growth. During the second quarter of fiscal 2022, Microchip paid record quarterly dividend of 23.2 cents per share, up 6.2% sequentially and 25.9% year-over-year. I expect the company will continue to pay growing dividends driven by continuing market share gains in microcontrollers and analog businesses. In addition, the company’s large exposure in automotive and industrial markets will help it grow dividends in the coming years driven by strong cash generation. Ongoing debt reduction will fuel growing dividend payment as well.
Microchip acquired a small early-stage semiconductor player based in Ireland during the quarter, known as Iconic RF. Iconic RF makes ICs (integrated circuits) primarily for the aerospace and defense market. The acquisition will help Microchip diversify its product offerings for this market, which will in turn result in long-term revenue growth for the company.
Microchip’s peer group companies include Analog Devices, Infineon Technologies, STMicroelectronics, ON Semiconductor, and Silicon Laboratories. Microchip’s non-GAAP forward (FY1) P/E multiple is 19.64x, compared to Analog Devices’ 23.33x, Infineon Technologies’ 24.97x, STMicroelectronics’ 24.38x, ON Semiconductor’s 24.21x, and Silicon Laboratories’ 105.21x. Microchip’s trailing 12-month price to sales multiple is 7.82x, compared to Analog Devices’ 9.55x, Infineon Technologies’ 4.69x, STMicroelectronics’ 3.60x, ON Semiconductor’s 4.51x, and Silicon Laboratories’ 8.80x. Microchip’s trailing 12-month price to cash flow multiple is 21.95x, compared to Analog Devices’ 33.76x, Infineon Technologies’ 16.91x, STMicroelectronics’ 14.47x, ON Semiconductor’s 18.81x, and Silicon Laboratories’ 50.73x (Data Source: Seeking Alpha).
Microchip is fairly valued compared to its peer group companies. However, the company is heavily indebted with a debt load of $8.24 billion and cash of $255.30 million on balance sheet. The company’s net leverage ratio is 3.22x, which is a bit worrisome. The good news is the company is rapidly paying down its debt. The company’s microcontroller and FPGA products enjoy strong demand in the marketplace, which is the reason why the company is not cheaply valued despite its indebtedness. The company’s non-GAAP gross profit has grown at a CAGR of 18.3% in the past ten years, and free cash flow has grown at a CAGR of 20.4% in the same timeframe, according to company sources. This indicates that the company is not only capable of substantially reducing its debt load in the next three to five years, but also paying dividend at a growing rate in the long term. The company’s Microsemi acquisition in 2018 has strengthened its datacenter, communications, and defense and aerospace businesses meaningfully, which will continue to drive revenue growth in the years to come. The company’s revenue has grown at a CAGR of around 12% in the past five years, and I expect revenue will grow at a CAGR of around high single-digits in the next five years. I am bullish on the company in the long term.
Assuming Microchip’s revenue will grow at a CAGR of around 9% in the next five years, I will find out the company’s long-term share price. The company’s trailing 12-month revenue is $6,038.40 million, and at a CAGR of 9% its beginning-2027 revenue will be $9,290.00 million, or $16.74 per share. In the last five years the company’s shares have traded between the price to sales multiples of 3x and 8x. I expect the company’s price to sales multiple will expand in the next five years driven by increasing demand for its shares, which will propel the multiple to around 10x. Applying a price to sales multiple of 10x on Microchip’s beginning-2027 revenue per share, I get $167.40 as the company’s beginning-2027 share price.
The company’s primary risk factor is its indebtedness. The company acquired a significant portion of its debt during the acquisition of Microsemi in 2018. However, the company is consistently paying off its debt, and generating growing cash flow, which are the reasons the company is becoming an interesting investing opportunity to long-term players. The company’s current credit ratings are favorable to investors. Any downgrade of the company’s current credit ratings could lead to increased borrowing costs, and as a result its share price could decline.
Manufacturing of non-volatile, erasable CMOS memory and logic devices are complex processes, which are sensitive to an array of external factors. These factors primarily include contaminants in manufacturing environment, and impurities in the materials used. These factors have a direct impact on manufacturing yields. If the company fails to maintain yields around the current level, its operating results could suffer.
Microchip is an appealing growth and income story to long-term investors. Its revenue and EBITDA is growing consistently over the past ten years. Rising demand for embedded control systems is boosting the company’s revenue growth. The company’s FPGAs enjoy strong demand in the marketplace since the products are made using low-power and non-volatile technology compared to traditional SRAM-based devices. Long-term investors can buy Microchip’s shares using proper pullbacks.
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