Electric vehicle (EV) chip supplier Allegro MicroSystems (ALGM 3.33%) has been a hot stock since its late 2020 initial public offering (IPO) -- but things have gotten a bit more bumpy for shareholders as of late. The market deemed a reduction in valuation was necessary following the update for the first quarter of fiscal 2024 (the three months ended June 2023), and a sizable acquisition of a privately held semiconductor design start-up didn't help much.
Shares are now down 25% from all-time highs. Is it time to buy shares of this top EV supplier?
Another good quarter, but a slowdown is looming
Allegro is a chip designer focused on power chips and magnetic sensors (which take advantage of the magnetic field that flow of electricity creates, more on that later). It provides these designs for automotive and industrial customers, and a bit for some consumer electronics companies, but Allegro has been leaning into the auto market as EV growth has been massive the last few years and is poised to continue.
It makes sense, given how much more silicon is needed in an EV compared to a traditional internal combustion engine (ICE) car -- think at least $1,000 of chip content per EV, versus maybe a few hundred dollars for an ICE vehicle.
Nevertheless, after a few years of stellar growth, it appears Allegro is starting to get throttled, much like other analog chip peers have been reporting as of late. Blame a global economic slowdown in 2023. At any rate, Q1 fiscal 2024 wasn't bad. Revenue was up nearly 28% year over year to $278 million, and earnings per share (EPS) under generally accepted accounting principles (GAAP) went from $0.05 last year to $0.31 this last quarter.
As for the second quarter, management forecast flattish sequential revenue in a range of $270 million to $280 million, although that still implies about a 16% increase from Q2 last year at the midpoint and just a bit of profit margin improvement.
A big purchase for small tech
Nevertheless, with a high premium on the stock, the market sold off Allegro following the quarterly update. But there's more. About a week after the Q1 report card, Allegro announced it will be acquiring magnetic sensor chip start-up Crocus Technology for $420 million in cash. Given that Allegro only had $353 million in cash on hand and only $25 million in debt at the end of June, the company will be raising new debt to pay for Crocus from the start-up's venture capital backers.
I don't own any Allegro stock, but if I did, the one thing that would give me serious pause is that Crocus is only expected to produce "sales in the low double-digit millions" in 2023 -- so let's say $20 million plus or minus $10 million. A $420 million price tag is quite the premium for a business this tiny.
At any rate, the acquisition does look like a good fit. Allegro is the leader in magnetic sensors, which are used in things like silicon carbide chips used in power systems in EVs and chargers, as well as speed and position sensors (like steering and braking systems). Allegro thinks it can plug Crocus into its supply chain and global sales network to rapidly scale up the small business's next-gen magnetic sensors.
With business slowing (at least for now) and new debt getting added to the balance sheet, Allegro doesn't look cheap enough to me right now. Shares trade for 31 times trailing-12-month earnings per share after the 25% sell-off. This one remains on my watch list, but I'm not buying yet.
