The semiconductor company has managed adversity smartly in the past, and is well equipped to handle another recession. The stock is cheap, the dividend rich.
Like most semiconductor stocks, shares of Microchip Technology have been hit hard by an industry slowdown. At a recent 33.29, they are off 17% from a mid-May high, stirring memories of an even more fearsome slide in 2008, when the economy and the chip business last went into a tailspin.
Investors who bought at the end of 2008 were rewarded with handsome gains, and that could occur this time, as well. The Chandler, Ariz.-based company (ticker: MCHP) has turned a profit for 83 consecutive quarters, notwithstanding an often bleak economic backdrop, and generates enough cash flow to support an annual dividend of $1.39 a share, for a current yield of 4.2%. What's more, the company has $1.4 billion of cash and investments net of debt, which equals $6.70 a share.
Courtesy of Microchip
With 70,000 customers, Microchip CEO Steve Sanghi has a good view of the global economy. The U.S. is already in a recession, he says, and Europe is worse.
"In a decent recovery, there is no reason why the shares shouldn't trade at or above 40," declares Diana Joseph, chief investment officer at Barrington Strategic Wealth Management, who owns shares for clients and in her own account, and says she would buy more if they fell into a range from 28 to 30. If developed economies grow modestly in the next few years, and emerging markets grow by 4%, Microchip Technology ought to see 10% to 15% annual profit growth, Joseph adds.
Profits are lumpy, however, as evidenced by current forecasts. Analysts expect earnings to fall about 10% in the fiscal year ending March 31, to $2.12 a share, from last year's $2.35. In fiscal '13, however, the company could earn $2.25, according to Wall Street estimates.
MICROCHIP SELLS MICROCONTROLLERS, the brains of electronic devices such as toasters, washers and thermostats, as well as cars. Its has 70,000 customers world-wide, giving it a good feel for where demand, particularly among consumers, is heading. Shares have fallen this year, in part because the company warned during the summer that business was slowing, and that fiscal second-quarter operating earnings could fall as much a 20% below year-earlier results, or to 50 to 54 cents a share from 63 cents in the year-earlier span.
CEO Steve Sanghi, 56, now believes the semiconductor industry's inventory correction is "nearing an end," with perhaps a quarter left to go. His outlook for the economy isn't as sanguine, however. "The U.S. economy is already in a recession," he says, noting that layoffs—and the unemployment rate—could rise in coming months. Friday brought some decent jobs news, for a change, with a report that the economy added 103,000 jobs last month, above expectations.
Sanghi views Europe as in even worse shape than the U.S., with a Greek debt default highly probable. China, he says, is slowing its economy in an effort to tame inflation. Microchip garners 20.9% of revenue from the Americas, 22.5% from Europe and 56.5% from Asia.
A lot of bad news is priced into Microchip's stock. Shares trade for 15.5 times forward earnings estimates, toward the low end of the company's historic price/earnings range of 12 to 37. Back out Microchip's cash stash, however, and the stock's P/E falls to about 12.4. Similarly, the company's ratio of enterprise value to sales, roughly 3.5 times, is at the lower end of the historic range, as is its enterprise value to earnings before interest, taxes, depreciation and amortization, according to ThinkEquity.
MICROCHIP, WHICH BOASTS A MARKET capitalization of $6.3 billion and annual revenue of $1.5 billion, has come a long way since 1987, when, as a money-losing division of General Instrument, it was spun out and purchased by a group of venture capitalists led by Sequoia Capital. Shares went public in 1993 at a split-adjusted 57 cents a share.
Sanghi came to the U.S. from India in 1976 to get his master's degree in electrical and computer engineering from the University of Massachusetts. He worked at Intel for 10 years and in 1990 joined Microchip as president. He became CEO the following year. The company's big idea: making microcontrollers that clients could customize themselves. The industry norm until then was to program chips to clients' needs. Microchip developed software tools enabling users to alter standard chips, cutting down on the time and expense of having them customized by a semiconductor company. "We needed to do something different to survive," says Sanghi. "Microchip came up with this programmable solution, and it revolutionized the market."
Because its chips are programmable, Microchip can sell the same chip to many different clients. The company has more than 800 chips, and its diverse customer base means that no single client contributes more than 2% to 3% of revenue.
Microchip started with 8-bit microcontrollers, and has expanded in recent years to 16- and 32-bit microcontrollers. They typically have faster processing speeds and can handle more sophisticated functions. Higher-end chips have greatly expanded the markets Microchip can address, with the result that it can offer clients more than one product.
About 68% of Microchip's revenue came from sales of microcontrollers in the June quarter. Another 14% came from memory products, 11% from analog chips and 5.5% from licensing.
INVESTORS WORRIED ABOUT the economy, and the possibility of a second, or "double dip," recession, can take comfort in Microchip's performance through the 2008-09 downturn. The company cut more than 20% of expenses without any layoffs. Office employees around the world, including those who design, research, sell and market its chips, were asked to take 10% pay cuts and forgo bonuses. Only two of 3,000 workers with guaranteed contracts refused.
With factory production cut by a third, the manufacturing staff was divided in thirds, with one-third furloughed every week. Microchip raised funds for employees in need. It took donations from employees and the company contributed $60,000 to the fund, which helped 300 workers. Sanghi donated to the fund as well but declined to disclose the amount.
The Bottom Line
Microchip Technology could rally to 40 from 33.29 if developed and emerging economies improve. The company has $6.70 a share in net cash and investments.
As business came back, the pay cuts and the length of the furloughs were slowly reduced, until employees returned to full pay and full hours. The process of cutbacks and reinstatements lasted from February 2009 until November of that year.
"Everyone stayed on the team," says Sanghi. "Our new products stayed on schedule and our salespeople kept calling on customers. When business recovered, we had the strongest pipeline in the industry." And through it all, the company paid quarterly dividends, even raising them slightly.
It is often said that you learn more about people when adversity strikes than when times are good. The same might also be said of companies. Microchip's past performance suggests that it knows how to manage downturns, and that it will emerge from the current rough patch even stronger than it had been before.
