Initial Report: Microchip Technology Inc. (MCHP), 32% 5-yr Potential Upside (VIP SEA, Nicolas DUQUE)
Nicolas is of the view that Microchip has a strong competitive advantage and maintains its dominant position in the MCU market. Let's read his analysis to understand why.
LinkedIn | Nicolas DUQUE
Executive Summary
Microchip Technology Incorporated develops, manufactures, and sells smart, connected, and secure embedded control solutions in the Americas, Europe, and Asia. The main offerings of the company are general purpose 8-bit, 16-bit, and 32-bit microcontrollers (MCUs); 32-bit embedded microprocessors; and specialized microcontrollers for automotive, industrial, computing, communications, lighting, power supplies, motor control, human machine interface, security, wired connectivity, and wireless connectivity applications.
Company Overview
Microchip focuses on providing solutions that enable smart, connected, and secure devices. The company offers a diverse portfolio of products, including microcontrollers, mixed-signal and analog devices, memory products, FPGA (Field-Programmable Gate Array) solutions, and more. These components are used by engineers and designers to develop innovative and efficient systems. In addition to its broad product portfolio, Microchip provides a range of software tools, development kits, and support resources to assist customers in their product development cycle. The company aims to simplify the design process and accelerate time to market for its customers. Microchip serves a wide range of industries, including automotive, industrial, consumer, aerospace and defense, and communications. Its products are utilized in applications such as advanced driver assistance systems (ADAS), Internet of Things (IoT) devices, power management systems, motor control, and wireless connectivity solutions.
In terms of revenue breakdown, Microchip Technology Incorporated has three main revenue streams: Microcontrollers Revenue, Analog Revenue, and Other Revenue. Microcontrollers Revenue represents the total sales generated by Microchip Technology's microcontroller segment, which includes the production and sale of small computer chips used in various electronic devices.
For the fiscal year ending 2023-03-31, Microcontrollers Revenue was $4.76 billion, representing 56.36% of the company's total revenue. Analog Revenue, which includes analog and mixed-signal products, accounted for 28.17% of the company's total revenue, or $2.38 billion. Other Revenue, which includes licensing and memory products, accounted for 15.48% of the company's total revenue, or $1.31 billion. Microchip Technology Incorporated's gross profit is primarily driven by its Semiconductor Products Gross Profit, which accounted for 97.17% of the company's total gross profit in the most recent trailing data. Technology Licensing Gross Profit accounted for the remaining 2.83% of the company's total gross profit.
Cost Drivers
Microchip Technology Inc. has undergone significant acquisitions in the past decade to diversify its product offerings, expand into new markets, and enhance its capabilities. Noteworthy acquisitions include Atmel Corporation in 2016, which bolstered Microchip's position in the microcontroller market and expanded its product portfolio[1]. In 2015, the acquisition of Micrel Inc. broadened Microchip's analog product offerings, particularly in power management and Ethernet solutions.[2] The 2014 acquisition of ISSC Technologies Corporation enhanced Microchip's wireless connectivity capabilities for IoT applications[3], while the Supertex Inc. acquisition expanded its presence in high-voltage analog and mixed-signal semiconductor solutions. Additionally, the acquisition of Standard Microsystems Corporation (SMSC) in 2012 strengthened Microchip's position in the automotive, industrial, and consumer markets by adding connectivity and networking capabilities. Through these acquisitions, Microchip has integrated new technologies and products, enabling the company to offer comprehensive solutions and solidify its standing as a leading semiconductor company.
The acquisitions made by Microchip Technology Inc., particularly those involving fabless companies, have indeed increased the company's exposure to foreign geopolitical issues. As mentioned by the Executive Chair of Microchip Steve Sanghi, a significant portion of Microchip's products are now manufactured outside of its own fabs, with only 42% being produced in their own fabs located in the United States.[4] The remaining products are produced by third parties such as TSMC, Global Foundries, etc. This increased reliance on global manufacturing and supply chain networks means that Microchip is subject to various geopolitical factors and risks. Here are a few ways these acquisitions have impacted Microchip's exposure to such issues:
Global Manufacturing: By acquiring fabless companies, Microchip has expanded its manufacturing footprint globally. This diversification allows the company to benefit from cost efficiencies and access specialized capabilities in different regions. However, it also exposes Microchip to potential disruptions due to geopolitical tensions, trade disputes, or changes in regional policies that may affect supply chain stability.
Supply Chain Dependencies: The acquisitions have likely increased Microchip's reliance on suppliers from different countries. Changes in trade regulations, export controls, tariffs, or geopolitical conflicts can impact the availability and cost of critical components and materials. Disruptions or delays in the supply chain due to geopolitical issues could potentially affect Microchip's ability to meet customer demand or introduce new products.
Intellectual Property and Technology Transfer: Acquiring fabless companies involves gaining access to their intellectual property (IP) and technology. While this enhances Microchip's product portfolio and innovation capabilities, it also necessitates careful management of IP protection and potential technology transfer risks. Intellectual property theft, trade secret infringements, or challenges related to export controls can arise in international contexts, potentially exposing Microchip to geopolitical challenges.
Revenue drivers
Microcontrollers are widely used in an array of products across industries. They are found in consumer electronics such as smartphones, tablets, cameras, and home appliances. In automotive systems, microcontrollers power functions like engine control units, infotainment systems, and advanced driver assistance systems. Industrial automation relies on microcontrollers for applications including robotics, PLCs, and sensors. Microcontrollers are at the heart of IoT devices, enabling connectivity and data processing for smart home devices, wearables, and industrial sensors. In the medical field, microcontrollers are crucial for patient monitoring systems and medical imaging equipment. Another important medical application includes medical Ventilators, the very devices that were highly sought-after by medical institutions during the development of the COVID-19 pandemic. Microcontrollers also have significant applications in aerospace and defense systems, energy management, home automation, and more[4, 5].
The versatility and capabilities of microcontrollers make them an essential component in a wide range of electronic devices, powering innovation across industries. These are the basic building blocks for the creation of smart cities and automated factories of the future.
Investment thesis
MCHP possesses a strong competitive advantage that stems from intangible assets like exclusive chip designs (such as the PIC MCU series), extensive manufacturing knowledge, and the high switching costs associated with changing suppliers once MCHP's analog and MCU chips are integrated into electronic devices. The company has consistently displayed robust financial performance and maintains its dominant position in the MCU market while expanding its analog business[6].
MCU manufacturers are required to meet rigorous quality standards, particularly in industries such as automotive, where any faults are unacceptable. New entrants face difficulties in achieving this level of quality while maintaining high production volumes. Microchip's 8-bit MCUs are distinctive as they are built on its proprietary PIC architecture. Furthermore, Microchip 's competitive advantage is reinforced by switching costs. Customers base their purchasing decisions on performance rather than price, allowing Microchip to retain its pricing power. Once electronic manufacturers select a chip, they typically stick with it for the device's lifespan due to the expenses involved in redesigning the product to switch to a competitor's chip. Executive Chair Steve Sanghi claims that “There is nobody who leaves earth orbit without Microchip onboard” in reference to its strong presence in the Aerospace sector[4, 7].
Microchip also boasts a diverse customer base, mitigating reliance on a single client or market segment. The company targets end markets with long product lines, such as automotive, industrial, and communications infrastructure sectors. In these industries, customers are unlikely to opt for lower-quality chips for minimal cost savings. By catering to a wide range of customers, Microchip avoids the same pricing compromises faced by companies operating in the PC markets. In addition, Customer-driven obsolescence, also known as obsolescence management, offers several benefits for Microchip. First, it enhances customer satisfaction by retiring outdated products and introducing newer ones that address evolving needs and provide enhanced functionality. Second, it streamlines the product portfolio, focusing resources on more profitable offerings and improving operational efficiency[4,8].
Valuation
Based on the available financial data and according to several analyses, it is possible to provide the future estimated price in the following year. The lowest forecast is 72.00 USD, which represents a downside of 16.16%. The highest forecast is 110.00 USD, which represents an upside of 28.09%. The average consensus forecast is 90.80 USD and represents an upside of 5.73% for the following fiscal year[9]. The current report suggests a price of 103.39 USD representing a 26% 3-year upside and a price of 108.26 USD for a 5-year 32% upside based on a discounted cashflow analysis which assumes a perpetuity growth terminal value (TV) over the EV/EBITDA TV. This report issues a BUY recommendation despite the 16.16% downside possibility which is in part based on the chances of Microchip not being able to manage the semiconductor unrealized demand trend that stemmed from the post-COVID era recovery, but which could be reversed due to the sector’s inherent cyclicality.
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.
References
[1] Eric Bjornholt, "MICROCHIP TECHNOLOGY TO ACQUIRE ATMEL"
[2] Eric Bjornholt, "MICROCHIP TECHNOLOGY AND MICREL ANNOUNCE THE COMPLETION OF THE ACQUISITION OF MICREL BY MICROCHIP TECHNOLOGY"
[3] Eric Bjornholt, "MICROCHIP TECHNOLOGY ANNOUNCES ACQUISITION OF ISSC TECHNOLOGIES"
[4] David Jones, "Talking with Steve Sanghi. 31 years as CEO of Microchip" EEVBlog Podcast
[5] "MMicrochip Technology Investor Presentation First Quarter Fiscal Year 2023
[6] George Atuan, CFA "Microchip Technology: A Strong, Diversified Chip Leader With Promising Growth Prospects"
[7] "Microchip Technology Incorporated annual report 2023"
[8] "Microchip Technology Incorporated (MCHP) Transcript Quarter Ending Feb '23"
[9] Example ratings: Christopher Danely, Citigroup. Rajvindra Gill, Needham. Toshiya Hari, Goldman Sachs