Microchip Technology (NASDAQ: MCHP) stock is selling off for more reasons than one, but its operational quality, market position, and outlook make this a buy-the-dip opportunity. Among the takeaways from the Q1 release are that near-term headwinds, including end-market inventory normalization and macroeconomic headwinds, weigh on the market today. Still, the long-term outlook for semiconductor solutions is robust.
The long-term outlook is robust because Microchip Technology is a leader in embedded control systems used by a diverse clientele, all facing a secular upgrade cycle. The upgrade cycle is driven by rapidly improving technologies related to AI. It will last for many years, leading to follow-on cycles as technology advances, sustaining operations and growth for this business. If (when) the FOMC cuts interest rates, there will be a tailwind to compound the business's inherent strengths, including a healthy capital return program.
Among the details suggesting this stock will rebound strongly are the analysts. The analysts are trimming their price targets following the release, but the cuts are marginal, and the consensus is for a 35% upside. Regarding the impact of revisions, the consensus is down following the release, but only by a dollar to $99, remaining within the tight range it has been in for the last year, showing a high level of conviction. More importantly, the stock sell-off is overblown, creating a deep value by trading beneath the analysts' lowest target of $80.
Microchip Technology Falters on Slow Return to Growth
Microchip Technology struggled in Q1 despite the “green shoots” mentioned in the previous reporting. The company’s net revenue of $1.24 billion is down 6% sequentially and 46% compared to last year, missing the consensus estimate due to the slow reboot of inventories in key end markets.
Margin is another area of weakness, although the news is better-than-expected. The company’s margin narrowed significantly at the gross and operating levels and on a GAAP and adjusted basis. Deleverage is the primary culprit, but one-offs include the amortization of acquisitions-related intangibles. The takeaway is that adjusted earnings are down more than 60% compared to the 46% top-line decline but beat the consensus estimate reported by MarketBeat by a penny.
As bad as the operational results are, the company continues to drive sufficient cash flow to sustain operational quality and capital returns. The free cash flow margin came in below last year but healthy at 25% of revenue, enough to sustain capital return with only a minor decrease in the cash balance. The capital return topped $315 million for the quarter, including dividends and share buybacks, compared to $304 million in free cash flow and $390.5 million in operating income.
Over the past twelve months, buybacks have been accretive to shareholders, reducing the count by an average of 1.5% in Q1. There is ample availability under the current authorization, so repurchases and dividends should continue. The dividend is worth about 2.4% in yield with shares near a one-year low, attractive on its own but more so because the distribution is growing. Microchip Technology has increased the payout yearly for over two decades and shows no signs of ending the trend. The Q1 report includes the latest increase, worth 10% to investors and more than enough to offset inflation.
The Technical Outlook: Microchip Technology Reverts to Trend
The price action in MCHP is down following the results and may remain under pressure for the next few weeks or months, but a rebound is expected before the year’s end. This stock is in a sustained uptrend and nearing price levels that have produced strong rebounds. Assuming the market takes advantage of this opportunity, shares of MCHP are unlikely to fall below $70 or stay there long if they do. The risk is that the recovery in power control markets will remain sluggish through year’s end, leaving this stock to wallow until business traction is regained.
