Technology offers some of the best investing opportunities today -- as well as some of the biggest potential pitfalls. New technologies such as cloud computing, AI, self-driving cars, and the Internet of Things have mouth-watering long-term growth prospects. Of course, with such opportunities often come stretched valuations, and if a company hits a roadblock, the ensuing sell-off can be brutal.
One of the best ways to figure out which trends are hot is to listen to the conference calls of companies with broad tech exposure. At the top of the list is Microchip Technology (NASDAQ:MCHP), helmed by CEO Steve Sanghi. Microchip sells microcontrollers, analog, and field-programmable gate array [FPGA] chips to an extremely broad set of customers -- especially since its acquisition of Microsemi last spring.
Because of its reach, Microchip gets an early look at demand trends in tech, often highlighting which sectors are growing and which are troubled well before others in the industry feel it. Here's what Sanghi and management had to say on Microchip's recent conference call with analysts.
Results strong, but next quarter will be difficult
Microchip reported a better-than-expected third quarter. Non-GAAP revenue of $1.52 billion beat expectations by $10 million, and non-GAAP earnings per share of $1.81 beat expectations by $0.08. But for the December-ended quarter, Microchip projects revenue to decline sequentially to $1.36 billion to $1.44 billion, and earnings per share to decline to $1.49 to $1.64.
The expected weakness next quarter is particularly telling. Microchip, like competitor Texas Instruments (NASDAQ: TXN), derives a majority of its sales from the automotive and industrial segments. According to the company, the automotive segment is being hurt by delays in emissions testing in Europe (causing production bottlenecks) as well as weak demand in China. Meanwhile, trade-war-fueled tariffs have led to widespread caution across the industrial segment.
On the bright side, data center and cloud computing continue to be strong, along with the smaller aerospace & defense and communications segments.
So if you're invested in the automotive industry, especially with exposure to China and Europe, things may be a little dicey over the next few quarters. However, cloud data center companies seem likely to continue their strong trend.
When will the downturn end?
Sanghi explained that Microchip gets a particularly early look into demand trends: "... numerous times in the past we have seen the impact of industry events about three, four months ahead of [when] the others see it. ... And now on the other side, we always come out earlier."
Unfortunately, Sanghi also said, "We are not fully ready to talk about the other end of the cycle yet," which means the broad auto and industrial weakness could last into 2019.
All this being said, Sanghi is confident in Microchip's products over the long term, citing the demand for microcontrollers, analog chips, Wi-Fi, ethernet, and Bluetooth connectivity:
That 2015 cycle, some of the assumptions were, like this thing is over. The industry just goes away, and all these things don't get designed in, and you can see how the business bounced back, and we had record quarters and record years and outstanding market share gains and everything else. So there is no long-term concern here, it's short term.
Microchip is a value
While Microchip surged almost 6% the day after earnings, the stock is still down over 25% from its 52-week highs. That could make the company a strong bounce-back candidate in the beaten-down semiconductor segment, if and when the cycle eventually turns around.
Of note, Microchip made progress winding down the excess inventory built up in Microsemi's distribution channel last quarter. That was a problem that emerged after the closing of the acquisition, and was explained in detail on last quarter's call. However, Microchip was able to work down Microsemi's excess inventory from about four months to 2.6 months in just one quarter, in line with legacy Microchip levels. At the same time, Microchip eliminated Microsemi's policy of giving discounts to certain customers, without seeing a decline in demand. "Fortunately, we are not easy to design out," said Sanghi.
And there are more cost savings to be had. While the company has already made progress, management says it will take two years to get through all the integration work. Microchip is also making progress in paying down its $10.9 billion debt load, reducing net debt principal by $315.5 million in the quarter.
While it's not a great thing to have such a large debt load while the economy hits a soft path, Microchip is highly profitable and should survive to the other side. Sanghi is a very straight shooter, and seems confident in the company's long-term prospects. Investors should be, too.