Microchip Technology (NASDAQ:MCHP) specializes in semiconductor devices known as microcontrollers, which are key to modern automation. They are to be found in nearly every electronic device, as they combine the ability to compute with the ability to sense and control external devices. Aware of their importance, I made Microchip one of my earliest stock purchases, back in 2007, and it is one of the few companies from that era that I have kept in my portfolio.
Because the stock price has roughly doubled in the past year, I recently forced myself to consider selling it. I concluded that, the usual caveats aside, Microchip has come closer to a fair valuation in the past year. But it still has future growth potential, so with the dividend, I see it as attractive up to the usual portfolio limits wise investors establish. My maximum for any one stock is 10%, but I keep most stocks at 5% of the portfolio or lower. Microchip currently represents about 5% of my portfolio.
There has been a lot written, even in the mainstream press, about a semiconductor chip shortage caused by the return of demand after factory slowdowns in 2021. Before considering Microchip specifically, I would point out that these kinds of chips are not easily interchangeable. Even something as simple as an 8-bit microcontroller generally cannot be popped into a board designed and programmed for a different brand of chip, or even a different chip in the same series made by the same manufacturer.
Given the costs of re-engineering the device, the software, and the production line, most of the time manufacturers will wait for the chip they planned on using rather than trying out a new chip. The Renesas fire on March 19, therefore, will not immediately help Microchip gain market share. Conversely, Microchip’s customers are sticky. Changing to another provider involves considerable cost.
As shown in the above chart, Microchip has roughly doubled in the past year. The 52-week low is $74.58, the 52-week high is $166.67, and the close on April 19 was $154.03. Clearly there has been some profit-taking recently, but that can be seen as an entry opportunity for those who see the current price as not yet in line with the company’s considerable future potential.
Microchip plans to report its March 2021 quarter (Fiscal Q4 2021) on May 6. In the December 2020 quarter revenue was $1.35 billion, up 5% y/y. GAAP and non-GAAP profit results varied substantially because of a $232 million amortization charge and a $142 million loss from a debt settlement. GAAP net income was just $36 million, down 88% y/y. GAAP EPS was $0.13, down 89%. But non-GAAP net income was $445 million, up 30% y/y. Non-GAAP EPS was $1.62, up 23%. Cash flow from operations was $510 million.
While Microchip runs its own fabrication plants, there were still supply restraints, and to some extent those are expected to continue through 2021. Bookings were strong in the quarter and that had continued into January. Backlogs were at record levels while inventory at distributors was at a record low.
All that would indicate that unless its restraints tightened further, the March quarter should see sequential growth. March quarter 2021 guidance (given February 4) included revenue estimated between $1.42 billion and $1.49 billion, GAAP EPS of $0.52 to $0.58, and non-GAAP EPS of $1.67 to $1.79.
For much of the past two decades Microchip has had low debt and a high cash balance. That changed due to a couple of largish acquisitions, the most recent one being Microsemi for about $8 billion in 2018. It had acquired its old rival Atmel in 2016 for about $3.6 billion. Since these acquisitions there has been an emphasis on using cash flow to pay down debt, rather than for stock repurchases. At the end of calendar 2020 Microchip had cash and equivalents of $373 million and long-term debt of $7.65 billion, after paying down about $0.5 billion in debt in the quarter.
There have been times in the last one-half century when smart people have wondered if the semiconductor industry was reaching a plateau. Accelerations and decelerations have occurred, but at present it looks like we are headed to ever more semiconductor use. The electronics packages in cars, for instance, have greatly expanded, and will expand more if semi-autonomous driving becomes a reality.
Microcontrollers can be hooked up to sense the outside world, and they can also be connected to affect it. That makes them indispensable for robotics, mechanization, and even control of non-mechanical electronic devices. Microchip is a leader in microcontrollers. While a macroeconomic dip could affect demand short term, the most likely path is increasing long-term demand. Microcontrollers are still a competitive industry, but the acquisitions of Atmel and Microsemi show that industry consolidation favors Microchip.
In some cases Microchip may see some demand softening for particular chips because of the circumstances of other companies. For instance, if some other type of chip or part from another company is not available, an automobile manufacturer might need to pause production. Then it would not be using any Microchip microcontrollers it had designed into its vehicles until production resumed. But I expect this sort of specific-product end-demand softness to evaporate as the global economy normalizes.
Microchip typically has raised the dividend by a very small amount each quarter. It made a larger increase for the current quarter, up 5.8% sequentially. The dividend is currently $1.56 per year, which works out to near 1% at the current stock price. The last ex-dividend date was February 19. Cash used to pay the prior dividend was $96 million. Clearly, Microchip has the cash and cash flow to continue to pay the dividend. Because the stock price has doubled while the dividend increased only slightly, the dividend is not as attractive as it was one year ago. I will be interested to see if more rapid dividend increases are announced.
As with most stocks, there may be periods of time when investors overvalue or undervalue Microchip. Since I believe it will continue to expand revenue and profits at least until the next macroeconomic down cycle, I see Microchip as an attractive long-term investment at the current price. I believe it was undervalued at the beginning of 2020, and the stock-price run-up is simply catching up to the economic realities.
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Disclosure: I am/we are long MCHP. 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.