Microchip Technology (NASDAQ:MCHP) Reports Q4 In Line With Expectations But Stock Drops

Analog chipmaker Microchip Technology (NASDAQ:MCHP) reported results in line with analyst expectations in Q4 FY2023 quarter, with revenue up 21.1% year on year to $2.23 billion. Guidance for next quarter's revenue was $2.29 billion at the midpoint, which is 1.47% above the analyst consensus. Microchip Technology made a GAAP profit of $604 million, improving on its profit of $437.9 million, in the same quarter last year.

Spun out from General Instrument in 1987, Microchip Technology (NASDAQ: MCHP) is a leading provider of microcontrollers and integrated circuits used mainly in the automotive world, especially in electric vehicles and their charging devices.

Microchip is a leading provider of microprocessors (MPUs) which are made up of microcontrollers (MCUs) and Digital Signal Controllers (DSCs). Microcontrollers are effectively mini computers on a chip, they consist of a CPU, some memory, an analog chip, and a simple, application specific software that tells the chip what to do.

Microchip’s microcontrollers are low cost customized chips that are in thousands of products. Examples would be automobile engine control systems, implantable medical devices, remote controls, office machines, appliances, power tools, or toys.

Digital Signal Controllers are a variation of microcontroller that measures, filters and/or compresses digital or analog signals. They are used in motor control, power conversion, and sensor processing applications, often in the same types of systems as a microcontroller.

Microchip has a design ecosystem and library of off-the-shelf components that allows its customers to design any kind of custom microprocessor they can think of.

Microchips’ peers and competitors include Texas Instruments (NASDAQ:TXN), Skyworks (NASDAQ:SWKS), and Infineon (XTRA:IFX), among others.

Analog Semiconductors

Longer manufacturing duration allows analog chip makers to generate greater efficiencies, leading to structurally higher gross margins than their fabless digital peers. The downside of vertical integration is that cyclicality can be more pronounced for analog chipmakers, as capacity utilization upsides work in reverse during down periods. Read More The semiconductor industry is broadly divided into analog and digital semiconductors. Digital chips are what most people think of as the brains of almost every electronic device. Their primary purpose is to either store (memory chips) or process (CPUs/GPUs) data. By comparison, analog chips regulate real world signals, such as temperature, speed, sound, or electrical current, converting them into a stream of digital data that can be processed by digital semiconductors. Analog semiconductors are also used to manage power in any electronic device; they convert, store and distribute the electrical energy that comes from a battery or wall plug. Analog chips are found everywhere from household appliances like refrigerators or washing machines, to smartphones, cars and factory production lines.

Sales Growth

Microchip Technology's revenue growth over the last three years has been mediocre, averaging 17.4% annually. And as you can see below, last year has been especially strong, with quarterly revenue growing from $1.84 billion to $2.23 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

This was a decent quarter for Microchip Technology as revenues grew 21.1%, topping analyst estimates by 0.4%. This marks 10 straight quarters of revenue growth, which means the current upcycle has had a good run, as a typical upcycle tends to be 8-10 quarters.

However, Microchip Technology believes the growth is set to continue, and is guiding for revenue to grow 16.5% YoY next quarter, and Wall St analysts are estimating growth 4.04% over the next twelve months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.

This quarter, Microchip Technology’s inventory days came in at 169, 37 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.

Pricing Power

Microchip Technology's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 68% in Q4, up 1.9 percentage points year on year.

Gross margins have been trending up over the last year, averaging 67.5%. Microchip Technology's gross margins remain one of the highest in the semiconductor sector, driven strong pricing power from its differentiated chips.

Profitability

Microchip Technology reported an operating margin of 47.6% in Q4, up 2.9 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.

Operating margins have been trending up over the last year, averaging 46.9%. Microchip Technology's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.

Earnings, Cash & Competitive Moat

Analysts covering the company are expecting earnings per share to be fairly flat over the next twelve months, although estimates are likely to change post earnings.

Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Microchip Technology's free cash flow came in at $596.8 million in Q4, down 5.73% year on year.

Microchip Technology has generated $3.13 billion in free cash flow over the last twelve months, translating to 37.1% of revenues. This is a great result; Microchip Technology's free cash flow conversion was very high compared to most semiconductor companies, in the last year. This high cash conversion, if maintained, puts it in a great position to invest in new products, while also remaining resilient during industry down cycles.

Over the last 5 years Microchip Technology has reported an average return on invested capital (ROIC) of just 11.3%. This suggests it may struggle to find compelling reinvestment opportunities within the business.

Key Takeaways from Microchip Technology's Q4 Results

With a market capitalization of $41.8 billion, more than $234 million in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

It was good to see Microchip Technology provide next quarter revenue outlook exceeding analysts’ expectations, although EPS guidance was in line. And we were also glad to see the improvement in gross margin. On the other hand, it was less good to see the inventory levels increase. Management also provided mixed macro commentary in the release. Overall, it seems to us that this was a complicated quarter for Microchip Technology. The company is down 7.92% on the results and currently trades at $70 per share.

Is Now The Time?

When considering Microchip Technology, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Microchip Technology is a good business. We would expect growth rates to moderate from here, but its revenue growth has been solid, over the last three years. And while its its relatively low return on invested capital suggests suboptimal growth prospects, the good news is its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion, and its impressive operating margins are indicative of an highly efficient business model.

Microchip Technology's price to earnings ratio based on the next twelve months is 12.3x. There is definitely a lot of things to like about Microchip Technology and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.

The Wall St analysts covering the company had a one year price target of $97.1 per share right before these results, implying that they saw upside in buying Microchip Technology even in the short term.

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