There's a present downturn in the semiconductor industry. Sales of PCs and smartphones tanked in the second half of 2022, and are expected to bottom sometime in the coming months before returning to growth in the second half of 2023.
This pain has spilled over into parts of the data center and cloud computing market as well, as businesses tighten their belts for what is expected to be a bumpy-at-best 2023. Other growing industrial markets -- including automotive -- have slowed down as well.
Through it all, though, Microchip Technology (MCHP 5.21%) has continued its fast-and-steady expansion. Microchip has also laid out plans for boosting its dividend and share repurchases in the coming years as a result. Did someone forget to tell Microchip about the chip downturn, or is there something special about this stock that should have investors' attention right now?
Microchip is designing its own "soft landing"
Many economists (and investors too) seem to think that the overall economy can no longer achieve a so-called "soft landing" this year after the Federal Reserve's record pace of interest rate hikes in 2022. In its latest meeting, the Fed seems to be indicating it will soon be finished with these interest rate hikes in light of the banking crisis.
Meanwhile, Microchip reported at the Raymond James Investor Conference on March 7 that it's still orchestrating its own "soft landing." What does that mean? After sales surged in the last two years as early effects of pandemic lockdowns wore off, Microchip doesn't see much evidence for a material drop in sales anytime soon.
Data by YCharts.
On the contrary, management had forecast about a 20% to 21% year-over-year revenue increase and a quarter-over-quarter revenue increase of 2.5% (to about $2.22 billion) for its fiscal 2023 fourth quarter ending in March 2023. And at the Raymond James conference, Microchip management said revenue for Q1 fiscal 2024 (ending in June 2023) will increase quarter over quarter, like it did in Q4 fiscal 2023.
Still with me? In dollar terms, that would equate to revenue of about $2.28 billion. Sales in Q1 last fiscal year were $1.96 billion, so Microchip's new guidance forecasts year-over-year growth of 16%. Microchip is slowing down, but this is far better than the revenue declines most of its peers are forecasting in the coming months.
Is there a secret ingredient at Microchip?
Granted, Microchip isn't a perfect company. I'm still a bit anxious about its balance sheet ($289 million in cash and short-term investments but $6.59 billion in debt) after a big strategic acquisition back in 2018. It's still working to pay down some of this debt over the next two years.
Nevertheless, Microchip has positioned itself well to capture long-term growth from multiple secular growth trends: industrial automation, automotive technology, and data centers. And while there's ample competition in the analog chips market (basically, sensors, dominated by companies like Texas Instruments and Analog Devices), Microchip is aiming more for the adjacent market of microcontroller chips that govern these analog silicon parts.
Over half of Microchip's sales are from microcontrollers (or MCUs, a device that contains a processor, embedded memory that stores a small software program, system timing chips, and other components that connect the MCU to the rest of a computing system). Its chip design and manufacturing peers like Texas Instruments and Analog Devices skew toward analog chips.
Additionally, Microchip touts what it calls a "total system solution." Basically, Microchip doesn't just sell commoditized parts. It helps its customers design an entire system, helps with the embedded software development (the software that tells the computer what to do), and connects all the other parts needed to finish off the system (like chips obtained from its peers).
In a world where computing technology is only increasing in importance for companies with a non-tech background, this is exactly the type of semiconductor partner you want in your supplier mix.
A top semiconductor stock for 2023 and beyond
Of course, management is still taking a cautious stance as the outlook for calendar year 2023 gets more clear. The chip shortage for industrial markets is coming to an end. A loosening of the chip shortage contributed to the nasty downturn for the PC and smartphone market late last year.
However, Microchip says it still has a massive backlog of orders to fill, which should help bridge any softening in short-term demand from its customers late this year and into calendar year 2024. It also has a fast-growing base of long-term purchase commitments from customers, since many of these industrialists (like automakers, for example) don't want to get caught with too little supply like they did in 2020 and 2021.
Long-term supply agreements have been an elusive luxury for chipmakers for decades, but the pandemic has shifted thinking at their client base. More stable demand could thus be a new norm for Microchip -- at least for the next few years.
In short, Microchip still thinks it will grow sales at an average low-teens percentage through 2025, all the while maintaining its high rate of profitability. Within the next two years, Microchip is targeting returning 100% of its free cash flow to shareholders via its dividend and stock buybacks, versus about 50% returned over the last year.
Data by YCharts.
As of this writing, Microchip trades for less than 15 times trailing-12-month free cash flow, and pays a growing dividend yielding 1.5% a year. Shares look like a great long-term value for investors interested in generating rising income. I've begun nibbling on this stock.
