Shares of Microchip (MCHP 1.79%) remain near all-time highs even though its primary customers in the automotive and industrial markets are in the midst of a slump. Clearly, investors are looking beyond some near-term pain and toward a new wave of growth at some point in the future for this Arizona-based chipmaker.
Microchip seems to be optimistic as well. It recently announced two small semiconductor business acquisitions for next-gen artificial intelligence (AI). Here's what investors need to know.
Data by YCharts.
Microchip has the fabs; now what to fill them with?
Microchip is a U.S.-based integrated device manufacturer -- i.e., a company that designs chips and manufactures them. In Microchip's case, it uses a hybrid model, employing both its own chip fabs as well as third-party foundries like Taiwan Semiconductor Manufacturing (NYSE: TSM).
As the world has suddenly become hyper-focused on the resiliency of semiconductor supply chains, Microchip picked up some funding from the U.S. CHIPS Act to bring some of that manufacturing home. The company scored a total of $162 million from the CHIPS Act in total:
- $90 million to expand and update its fab in Colorado Springs.
- $72 million to expand its fab in Gresham, Oregon.
In particular, Microchip will be using these funds to grow production of its microcontrollers, a type of processor crucial to functions in cars, industrial equipment, aerospace and defense, and data centers.
But perhaps with the forthcoming extra manufacturing capacity, Microchip thinks it can do a bit more. Enter the acquisition of start-up Neuronix AI Labs, to expand Microchip's ability to develop chips that process AI "at the network edge" (i.e., in devices like cars and robotics); and small South Korean company VSI, which develops data networking chips for advanced driver-assist systems (ADAS).
The price tag was not disclosed for either of these acquisitions, which means they were likely for small sums. But even as its industrial customers work through some excess chip inventory (the reason Microchip's revenue and profitability have been in reverse the last couple of quarters), management is looking beyond the present downturn and is betting on rising AI needs from automakers and the like.
Management knows how to cut a deal
Microchip, in its present form, is the result of a megamerger with Microsemi in 2018. Ever since then, management has been working off the debt to make that transformative move, resulting in fantastic shareholder returns the last few years.
Data by YCharts.
The two new AI acquisitions are anything but transformative, but Microchip has proved it knows how to cut a deal and turn it into higher profitability. Even when including the latest cyclical downturn, trailing-12-month free cash flow is up more than 130% since the start of 2018.
As an important tech hardware partner to all sorts of non-tech industrial companies, Microchip is already positioning itself to help with the coming wave of AI innovation. Shares trade for about 28 times expected current fiscal-year earnings per share (EPS), which factors in lower sales and profit than in 2023.
However, semiconductor companies are anticipating the next wave of growth will begin in the second half of 2024 -- reflected in Microchip shares trading for just 19 times next fiscal year's expected EPS. Microchip deserves to be on investors' radar as a top AI stock for the decade ahead.
