Microchip Technology's (MCHP 1.51%) 2024 fiscal year (the 12-month period that will end in March 2024) is suddenly turning ugly, but the stock is holding up pretty well considering. Share prices are down 20% from all-time highs reached a couple of months ago, but actually rallied slightly after management offered a not-so-great outlook for the closing months of calendar year 2023.
The reason? Microchip has gotten itself in excellent shape after a spate of rapid and profitable growth in the last couple of years, and it's a top dividend stock that has managed many downturns before. Is it a buy now?
A top all-weather chip stock
Microchip is a top provider of microcontrollers (a type of processor that controls a specific function in a piece of equipment), analog chips (sensors), and "total solutions" spanning computing systems and integrated software. Its customers slant heavily toward industrial (41% of revenue), data center (19% of revenue), and automotive (17% of revenue) businesses.
Perhaps you've heard, besides booming AI chips from the likes of Nvidia, and the PC and smartphone market finally bottoming and heading toward a long-awaited rebound, industrial-focused chips like what Microchip specializes in are headed for a downturn after holding up particularly well during the bear market.
Indeed, revenue growth has been impressive, soaring nearly 70% higher since the start of 2021 as industrial automation and automotive technology has been in high demand. And like in the last couple of quarters, even as some of its peers reported weakening sales, Microchip once again reported revenue growth in Q2 fiscal 2024 (the three months ended September 2023) of 8.7% year over year to $2.27 billion.
The problem, though, is guidance as the current industrial chip downturn has finally come for Microchip too. Management guided for a 14% year-over-year sales decline for the quarter that will end this December. Customers are in cash-conservation mode as interest rates have spiked this year, and many are asking Microchip to cancel or delay orders.
However, Microchip's end markets have always been cyclical, and this time looks no different. This was my favorite quote from CEO Ganesh Moorthy on the earnings call:
Our experience from prior cycles is that at this stage of the cycle, customers tend to overcorrect their inventory and backlog due to their business uncertainty, combined with the availability of product with very short lead times. This is, in effect, the flip side of what we saw during 2021 and 2022, when demand was historically strong and seemingly insatiable.
In other words, customers are in a panic right now, just as they were in a panic to buy every chip they could two years ago. The cycle will repeat, and Microchip expects its long-term growth trajectory (average annual revenue growth of 10% to 15% through fiscal year 2026) to persist.
Microchip is great for growth and income
Microchip has a long track record of remaining highly profitable even during downturns. In fact, though it expects sales to temporarily retreat next quarter, its outlook for adjusted operating profit margins remains north of 41%.
With the exception of those few cyclical bumps, free cash flow generation has been steadily on the rise over the years. This has allowed the company to aggressively pay down debt from a big acquisition in 2018, repurchase plenty of stock ($340 million worth last quarter alone), and increase the dividend payout.
Data by YCharts.
Wall Street analysts are figuring a mid-single-digit earnings per share (EPS) decline is in the works for the current fiscal year. I agree. But it's too soon to tell what next year (calendar year 2024 and into 2025) will look like. I'm figuring for a resumption of growth before too long, given AI (read "automation," a way for businesses to save money) and the digitization of autos is continuing to expand at a rapid pace.
With this as an assumption, I plan on continuing to accumulate shares of Microchip during this downturn through the dollar-cost averaging plan I have in place. Shares trade for just under 17 times trailing-12-month EPS and 13 times trailing-12-month free cash flow. It looks like a very reasonable valuation for a top semiconductor company that I expect will enjoy secular growth propelling it forward for many years to come.
