Analog chipmaker Microchip Technology (NASDAQ:MCHP) fell short of analysts' expectations in Q2 FY2024, with revenue up 8.74% year on year to $2.25 billion. Turning to EPS, Microchip Technology made a non-GAAP profit of $1.62 per share, improving from its profit of $1.46 per share in the same quarter last year.
Microchip Technology (MCHP) Q2 FY2024 Highlights:
- Revenue: $2.25 billion vs analyst estimates of $2.27 billion (0.53% miss)
- EPS (non-GAAP): $1.62 vs analyst expectations of $1.62 (small miss)
- Revenue Guidance for Q3 2024 is $1.86 billion at the midpoint, below analyst estimates of $2.11 billion
- Free Cash Flow of $541.8 million, down 38.6% from the previous quarter
- Inventory Days Outstanding: 167, up from 167 in the previous quarter
- Gross Margin (GAAP): 67.8%, in line with 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.
Sales Growth
Microchip Technology's revenue growth over the last three years has been solid, averaging 19.8% annually. But as you can see below, this quarter wasn't particularly strong, with revenue growing from $2.07 billion in the same quarter last year to $2.25 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).
Microchip Technology had a slow quarter as its unremarkable 8.74% year-on-year revenue growth missed analysts' estimates by 0.53%. This was its third consecutive quarter of decelerating growth, indicating a potential cycle downturn.
Microchip Technology's revenue growth has decelerated over the last three quarters and its management team projects growth to turn negative next quarter. As such, the company is guiding for a 14.3% year-on-year revenue decline while analysts are expecting a 5.61% drop over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity 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 DIO came in at 167, which is 36 days above its five-year average, suggesting that the company's inventory levels are higher than what we've seen in the past.
Pricing Power
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Microchip Technology's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 67.8% in Q2, up 0.3 percentage points year on year.
Gross margins have been trending up over the last year, averaging 67.9%. These are some of the best margins in the semiconductor sector, driven by strong pricing power from its differentiated, value-add products.
Profitability
Microchip Technology reported an operating margin of 48.1% in Q2, up 1.3 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Microchip Technology's operating margins have been trending up over the last year, averaging 47.8%. On top of that, the company's margins are some of the highest in the semiconductor industry, driven by its highly efficient operating model and economies of scale.
Earnings, Cash & Competitive Moat
Wall Street expects earnings per share to decline 10.8% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Microchip Technology's free cash flow came in at $541.8 million in Q2, down 20.7% year on year.
As you can see above, Microchip Technology produced $3.16 billion in free cash flow over the last 12 months, an eye-popping 35.4% of revenue. This is a great result; Microchip Technology's free cash flow conversion places it among the best semiconductor companies and, if sustainable, puts the company in an advantageous position to invest in new products while remaining resilient during industry downturns.
Over the last five years, Microchip Technology has reported an average return on invested capital (ROIC) of just 12.5%. This suggests it struggled to find compelling reinvestment opportunities within the business.
Key Takeaways from Microchip Technology's Q2 Results
With a market capitalization of $38.7 billion, a $256.6 million cash balance, and positive free cash flow over the last 12 months, we're confident that Microchip Technology has the resources needed to pursue a high-growth business strategy.
We struggled to find many strong positives in these results. Its revenue missed Wall Street's estimates and its revenue guidance for next quarter underwhelmed. Lowered top-line expectations are something we've observed in the semiconductor industry this quarter amid macroeconomic concerns. Overall, this was a mediocre quarter for Microchip Technology. The company is down 3.37% on the results and currently trades at $71.1 per share.
Is Now The Time?
Microchip Technology may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We think Microchip Technology is a solid business. We'd expect growth rates to moderate from here, but its revenue growth has been solid over the last three years. And while its relatively low ROIC suggests suboptimal profitability prospects, the good news is its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion. On top of that, its impressive operating margins indicate a highly efficient business model.
Microchip Technology's price-to-earnings ratio based on the next 12 months is 12.8x. There are definitely 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.
Wall Street analysts covering the company had a one-year price target of $95.6 per share right before these results, implying that they saw upside in buying Microchip Technology even in the short term.
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