Analog chipmaker Microchip Technology (NASDAQ:MCHP) reported results in line with analyst expectations in Q3 FY2023 quarter, with revenue up 23.4% year on year to $2.16 billion. Guidance for next quarter's revenue was $2.22 billion at the midpoint, which is 1.53% above the analyst consensus. Microchip Technology made a GAAP profit of $580.3 million, improving on its profit of $352.8 million, in the same quarter last year.
Microchip Technology (MCHP) Q3 FY2023 Highlights:
- Revenue: $2.16 billion vs analyst estimates of $2.15 billion (small beat)
- EPS (non-GAAP): $1.56 vs analyst estimates of $1.54 (small beat)
- Revenue guidance for Q4 2023 is $2.22 billion at the midpoint, above analyst estimates of $2.18 billion
- Free cash flow of $1.13 billion, up 66.4% from previous quarter
- Inventory Days Outstanding: 152, up from 139 previous quarter
- Gross Margin (GAAP): 67.8%, up from 65.6% 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), Infineon (XTRA:IFX), NXP Semiconductors NV (NASDAQ:NXPI), ON Semi (NASDAQ:ON), Marvell Technology (NASDAQ:MRVL), and Analog Devices (NASDAQ:ADI)
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.
Microchip Technology's revenue growth over the last three years has been mediocre, averaging 15.6% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $1.75 billion to $2.16 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 23.4%, topping analyst estimates by 0.77%. This marks 9 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 20.5% YoY next quarter, and Wall St analysts are estimating growth 6.72% 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 152, 23 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.
Microchip Technology's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 67.8% in Q3, up 2.2 percentage points year on year.
Gross margins have been trending up over the last year, averaging 67%. Microchip Technology's gross margins remain one of the highest in the semiconductor sector, driven strong pricing power from its differentiated chips.
Microchip Technology reported an operating margin of 47.4% in Q3, up 2.8 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 46.1%. 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 grow 5.59% 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 $1.13 billion in Q3, up 49% year on year.
Microchip Technology has generated $3.17 billion in free cash flow over the last twelve months, translating to 39.3% 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.
Microchip Technology has an average return on invested capital (ROIC) of 10.4%, over the last 5 years. That's not bad, and suggests the business can grow profits, but it isn't particularly impressive compared to other semiconductor companies.
Key Takeaways from Microchip Technology's Q3 Results
With a market capitalization of $44.6 billion, more than $288.9 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 improve their gross margin this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. On the other hand, it was less good to see the inventory levels increase. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. But the market was likely expecting more and the company is down 2.14% on the results and currently trades at $82.75 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. Although we have other favorites, we understand the arguments that Microchip Technology is not a bad business. However, its revenue growth has been mediocre, and analysts expect growth rates to deteriorate from there. But on a positive note, its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion.
Microchip Technology's price to earnings ratio based on the next twelve months is 14.0x. In the end, beauty is in the eye of the beholder. While Microchip Technology wouldn't be our first pick, if you like the business, the shares are trading at a pretty interesting price point right now.
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