Wednesday, June 20, 2007

Buying Opportunity in Undervalued Microchip (MCHP)

Microchip announced yesterday that sequential revenue growth from Q1 2007 to Q2 2007 is likely to come in around 2%, disappointing investors who had relied on previous guidance for 5% growth. Earnings projections were not as bad. The press release said earnings per share are expected to be $0.36 (GAAP), which is only one penny short of prior guidance.

Investors, of course, had hoped Microchip would do better than guidance; it often does. So the stock plumetted yesterday (due to auction price movement amplification). I believe it is was already slightly undervalued before the news. Yesterday's news and price fall leaves it undervalued. (I own the stock but have no plans to buy or sell in the near future because it has appreciated as a percentage of my portfolio to the point where my rules do not allow me to buy more; but not to where my rules require me to sell it).

If you look at the Q1 results and analyst conference held on April 26, 2007 (See my summary), you'll see revenues were $258.2 million. A 2% increase will bring them to $263.3 million. In Q2 2006 revenues were $262.6 million, so revenues will be about flat year-over-year. GAAP earnings were $0.35 per share, so we can expect only a 3% year-over-year increase in earnings when Q2 2007 results are announced.

Can a stagnant semiconductor company be undervalued when its trailing price-to-earnings ratio is 23.37 (per NASDAQ, at a price of $37.70 per share)? I think there are three details that need to be considered.

First, at the end of Q1 Microchip had $1.3 billion in cash and equivalents. That is 15.8% of today's market capitalization of $8.2 billion. It is especially healthy when you consider MCHP pays out $1.12 per share per year in dividends.

Second, there is the reason revenues are falling below prior guidance. Demand in Europe has been weaker than expected this quarter. Memory prices have been low so management chose to pass up sales that would have hurt profit margins. Memory is an adjunct businesss for Microchip, which is best known for its microcontrollers and which has also moved aggressively into analog chips. Low memory prices are an industry-wide phenomena that has been widely reported.

Last quarter Microchip reported it had finally become the leading global supplier of 8-bit microcontrollers. But the fastest growth is in 16-bit microcontrollers. They report that this quarter they continue to have strong 16-bit microcontroller revenue growth. Hence the good net income expectations despite the dissappointing revenue growth.

Third, I believe that inventories across the industry are lean and that worldwide demand will be good in Q3 as electronic device manufacturers gear up for the holiday Q4 rush. So demand for analog chips and microcontrollers should be strong in Q3. In 2006 Q3 was in the opposite situation: end-users had overstocked in early 2006 and were trying to reduce inventories.

So Q3 year-over-year comparisons should look healthy and justify a higher price-to-earnings ratio than the stock has today.

On the other hand I don't see a period of hypergrowth ahead for Microchip. Steady growth with a very healthy dividend is the picture here. The microcontroller industry is very competitive, but Microchip has worked its way up through the ranks. I expect it to remain at the top; I like management's commitment to profitability.

More information:

Microchip Investor Relations Page
My Microchip (MCHP) Page

No comments:

Post a Comment