Monday, November 28, 2011

Microchip (MCHP) Inventory Correction End May Be Near

There is no way to describe Q3 2011 as a good quarter for Microchip (MCHP). The maker of microcontroller and analog chips reported revenues of $340.6 million, down 9% sequentially from $374.5 million in Q2 and down 11% from $382.3 million in the year-earlier quarter.

GAAP net income was $79.3 million, down 20% sequentially from $99.3 million and down 24% from $104.7 million year-earlier. GAAP EPS were $0.40, down 18% sequentially from $0.49 and down 26% from $0.54 year-earlier.

Given that and the general stock-market and macroeconomic malaise, the main thing propping up Microchip's stock price (closing today at $33.07) is the dividend, now running at $1.392 per share per year, or 4.3% at today's price.

As to the outlook, Q4 guidance was week, with revenue in the range of flat to down 7% from Q3.

I don't think that Microchip is failing to compete in its market segments. It continues to be the world's leading microcontroller provider. Economic uncertainty caused weakend demand, which in turn caused OEMs to tighten up their inventories.

Then again, the picture could be brighter for Q1 2012. The first quarter is typically seasonally slow for semiconductor chip makers, but within that seasonality Microchip's management, as early as the analyst call on November 3, foresaw an uptick, predicting that "shipment rates in December will be below the consumption rates of our customers."

Here it is important for analysts to note that, unlike most chip manufacturers, Microchip does not recognize revenue when it makes shipments to distributors. Because of the nature of Microchip's business (selling a large number of parts to a large number of OEMs), a lot of sales are through distributors. Microchips recognizes the revenue when the distributors have shipped the chips to end customers.

This means that Microchip tends to see results (reported revenue) of general semiconductor trends, both up and down, a quarter earlier than its peers. While there can be differences in results because of focus and competition for market share, a Microchip revenue downturn is a fair predictor of a sector downturn one quarter later, and the same for upturns.

If this December shapes up to be a good one for electronics sales in the U.S., and if Europe holds together, January may look very different than most investors would have expected until recently. If end sales cause inventory shortages at OEMs, the pace chip sales in Q1 could be strong, compared to the usual range from seasonality.

So keep an eye on Microchip's Q4 results and Q1 2011 results. In the meantime, if you are holding MCHP, enjoy the dividends.

Keep in mind that the semiconductor industry, including its microcontroller and analog segments, is very competitive.

Disclaimer: I am long MCHP and have no plans to change my position this year.

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