Featured today on Smartmoney interactive
CAN CHIP STOCKS GET
ANY RESPECT?
DOES An UPGRADE of a stock in a lousy market mean anything?
That's the question facing investors in Microchip Technology (MCHP), our pick in today's bottom-fishing chip stock screen.
Microchip is one of 21 semiconductor companies that have
been trading at less than half their 52-week high, a dismal statistic they share despite a strong overall record of earnings growth in the past few years.
Needham & Company's Tad Lafountain on
Thursday upgraded Microchip from Hold to
Buy, but the reasons are rather prosaic. No
preannouncement, no dramatic bump-up in
orders. MCHP is simply running smoothly,
growing a little less rapidly than it used to under
the burden of Asia/Pacific, but not falling apart
either. Morgan Stanley analyst Mark Edelstone,
who's generally bullish on the stock, says the
breadth of its products and the markets it serves,
make Microchip "basically a proxy for the world
economy." So if you think the U.S. can avoid a
recession, then MCHP may be primed for some
operating improvement in its chip business that
would boost its bottom line.
The stock's been a lousy one to own in the last
year, plummeting from a high of 45 last
September, after a nice runup in which it handily
outpaced the S&P 500 over five years, to a
52-week low of 18 on Monday. Microchip is the
leader in programmable microcontrollers, tiny
integrated circuits that find their way into just
about everything, from laptop battery chargers
and air bag control systems to cell phones.
The chips are sold through a network of
third-party distributors to just about everyone,
including Nokia (NOK/A) and General
Electric (GE). About 65% of those sales are
linked to Asia and Europe, so it's no wonder that
Microchip failed to meet earnings and revenue
projections back in the March quarter of this
year.
The slowdown in Asia hit Microchip at the
beginning of the year just as it was ramping up
R&D. As a result, sales were down
year-over-year in the first quarter of this year,
from $93.6 million to $93.2 million, and gross
margins declined a couple of percentage points
as the company marked down its wares to stay
in the lead. Despite MCHP's having a 25%
secular growth rate, the company turned in
mediocre earnings at the beginning of the year,
bringing in 26 cents in the first quarter of this
calendar year vs. 30 cents last year, and
disappointing estimates by a penny.
So has anything changed with the company in
nine months? The picture started to turn in June,
when Microchip reported an increase in revenue
of 7% and beat the Street by a penny. However,
since that time, the stock has entered a trading
pattern where the only strategy that seems to
make sense is to buy on the dips, hold for 10
points, and then sell for a profit. The latest
market ups and downs have offered those kinds
of short-term gains: Microchip was down to a
new low of 18 on Monday, up 26% on Tuesday,
and Friday sank back down to 21 1/2.
There's little news in La Fountain's research note
except to confirm that the reaction to Asia may
have been overblown. He says MCHP is on
track to increase revenue in the next year by
10%, or about $435 million this fiscal year vs.
$397 million last year. And though it will
probably deliver slightly less in earnings this
quarter than it did a year ago, meaning 33 cents
per share vs. 34 cents, Microchip is expected to
increase profits for the year, from $1.14 to $1.29
per share, up 13%. La Fountain says the
company is proceeding with so-called process
shrinks at its chip fabrication facility in Tempe,
Ariz., which will make its circuits smaller and
more efficient -- proof of MCHP's continued
determination to be a chip technology leader.
And once the company bounces back from the
slump this year, it should grow 39% next year,
for $1.70 per share in earnings in fiscal 2000.
Morgan Stanley's Edelstone says the company
should get an immediate boost from the holiday
selling season, as Microchip's integrated circuits
are used heavily in consumer goods.
In fact, the substance of La Fountain's note is
that Microchip is obviously cheaper today than it
was a couple of weeks ago. He thinks the
company deserves a premium P/E of 21 vs. its
compounded growth rate of 19%. If so, MCHP
has lots of room to grow to meet his 12-month
price target of 30, which he arrives at by
multiplying an estimated $1.40 per share in
earnings in the next 12 months by a P/E of about
20.9, a slight premium to its current EPS growth
rate.
Edelstone concurs the company deserves a
premium: He thinks the overall revenue bump in
the second quarter and the 10% increase this
year are evidence the company is growing faster
than the rest of the semiconductor sector,
therefore justifying a $40 price tag in the next 12
months.
In other words, nothing's changed, but the stock
should enjoy some multiple expansion going
forward. The stock's price-to-book value is way
down from something like six times book value
per share in earlier years to about 3.7 these days,
while its P/E has declined by about 40% or more
in the past few years. If the market decides to
stop punishing stocks for expensive valuations,
and if MCHP doesn't disappoint on a
fundamental basis, some return to higher
multiples of the past seems reasonable.
There's just one thing: This is obviously not a
stock you want to hold if the economy is going
to hell in the next six months. Expectations are
high that the company will return to 25% revenue
growth and something like 19% compounded
earnings growth in fiscal 2000, which starts next
April. That's normal operating procedure for
Microchip, and any more hiccups could send
the stock careening. Add in the fact that the
rapid nature in which the company receives and
fills orders within the quarter -- called "turns
orders" -- makes forecasting earnings somewhat
dicey.
Last spring, for example, the company issued
conservative guidance for the June quarter, only
to turn around and issue an upside
preannouncement on June 30. Given that the
company weathered the perils of Asia in the first
half of the year with a good showing and
increased its microcontroller business, there's
reason to believe MCHP's business will be fairly
resilient in the next 12 months. Keep in mind that
the stock is now right back where it was nine
months ago, when it had a trailing P/E of about
21. Hence, there may be little risk in buying in at
the current trailing P/E of 18 and hoping things
will pick up from here.
Finally, remember that this stock tends to trade
in tandem with Intel; its dips follow Intel's drops,
and the same for the climb back up. If you
believe Intel's fortunes are headed for a
turnaround in the next few months, you might
want to take a second look at Microchip.
-- By Tiernan Ray
Regards
Neil |
