TipRanks Smart Dividend Newsletter – Edition #30
Hello and welcome to the 30th edition of TipRanks’ Smart Dividend – a weekly Newsletter providing you with investment ideas for safe-bet quality stocks that are outstanding dividend payers, compared to their peers.
Today’s dividend stock recommendation is a leading provider of mixed-signal microcontrollers and analog integrated circuits, considered to be one of the best-managed companies in the semiconductor industry.
Investment Thesis: Chipping In
In a world increasingly driven by technology, the semiconductor industry, particularly the sectors focusing on microcontrollers and analog circuits, plays a crucial but often understated role. These components, though small, are essential in powering a wide range of applications from industrial machinery to the burgeoning Internet of Things (IoT) landscape. The significance of this sub-industry lies in its ability to provide the foundational elements for countless innovations and everyday functionalities.
Microcontrollers and analog circuits are at the heart of modern automation and smart technology. Their presence spans various sectors, making them integral to the advancement of industrial capabilities, the development of autonomous vehicles, the ascent of data centers, and the expansion of IoT networks. This specialized segment of the semiconductor industry is characterized by a steady demand, driven by the continuous need for enhanced efficiency, precision, and connectivity in both consumer and industrial electronics.
The emphasis within this industry is on sustained, incremental innovation, focusing on enhancing performance and reducing the size of these critical components. Companies excelling in this space are not only addressing the current needs of a technology-dependent society but are also laying the groundwork for future developments in smart technology and industrial automation.
For investors, this segment of the semiconductor industry presents an opportunity to engage with a market that combines reliability with the potential for steady growth. It’s an investment in the unseen yet indispensable elements that keep the wheels of technology and industry turning, offering a more focused and perhaps prudent approach to participating in the broader tech sector’s growth narrative.
Quality Dividend Stock: This Week’s Top Pick
Microchip Technology, Inc. (MCHP) develops, sells, and manufactures smart, connected, and secure embedded control solutions. MCHP is a leading provider of mixed-signal microcontrollers (MCU), analog integrated circuits, and other semiconductors, as well as computing systems and integrated software solutions.
The company provides scalable 8-bit, 16-bit, and 32-bit microcontrollers (MCUs), digital signal controllers (DSCs) and microprocessors (MPUs); mixed-signal, linear, interface and power products; amplifiers and linear integrated circuits (ICs); precision timing systems; data converter ICs; embedded and industrial controllers; field-programmable gate arrays (FPGAs) and programmable logic devices (PLDs); high-speed networking and video products; interface and connectivity solutions; high-quality memory products; power discrete solutions; power management devices; radiofrequency (RF) and microwave products; MPUs and MCUs with integrated security solutions; high-accuracy sensors for complex, real-world applications; data access, storage and protection solutions; touch and gesture products, and more. In addition, MCHP offers customizable smart energy platforms, as well as circuit design, infrastructure synchronization, miniaturization, microelectronics assembly, and other services.
Microchip Technology was established in 1987 when it was spun off from its former parent company, General Instruments, at first as a wholly owned subsidiary. In 1989, Microchip Technology became a fully independent company; the company’s stock began trading on NASDAQ in 1993.
During the years since its establishment, MCHP has expanded its business offers, end-market list, and geographical presence, through internal efforts such as heavy investment in research and development (R&D) and production capacity expansion, as well as numerous acquisitions. Its most recent acquisition was a 2020 buyout of New Zealand-based Tekron International, a provider of high-precision GPS and atomic clock time-keeping technologies and solutions for the smart grid and other industrial applications.
Notably, the company’s latest big-ticket buyout was in 2018, when MCHP bought MicroSemi Corporation, a provider of semiconductor and systems solutions for aerospace and defense, communications, data center, and industrial markets. This and previous acquisitions helped Microchip seize the opportunity to expand its product and solution lineup and solidify its market position vis-à-vis its competitors. Since then, MCHP has prioritized paying down debt and increasing shareholder compensation over acquisitions.
While the pace of acquisitions has slowed in recent years, Microchip’s capacity expansion and R&D efforts have been accelerating. Thus, in March this year, the company announced faster-than-expected progress on its multi-year, $800 million initiative aiming to triple production capacity at its Gresham, Oregon manufacturing facility. In February, MCHP published its plans to invest $880M to expand its silicon carbide (SiC) and silicon (Si) production capacity at its Colorado Springs manufacturing facility over the next several years. In July, the company inaugurated a third R&D center in India; in December, it announced the opening of a major new design center at Cambridge, U.K. In October this year, Microchip expanded its Detroit Automotive Technology Center in Michigan, which develops products and solutions for the company’s clients from the automotive industry. In addition, Microchip partners with industry-leading companies to develop cutting-edge products. Thus, its collaboration with GlobalFoundries Inc (GFS) has produced a third-generation embedded SuperFlash technology non-volatile memory solution.
Today, Microchip is one of the largest semiconductor companies in the world, commanding a market capitalization of $50 billion, annual revenues of $8.5 billion, and a workforce of 22,600 employees in its Chandler, Arizona headquarters as well as in its production and research facilities in the U.S., Canada, Europe, Middle East, and Asia-Pacific.
The company offers approximately 100,000 products to over 125,000 customers in the industrial, automotive, aerospace and defense, data center, appliance, and communications end markets. The company’s business is diversified by end-market composition: industrial use end market is responsible for 41% of revenues, while the data center and computing market provides 19%, automotive – 17%, consumer appliance – 12%, and communication – 11% of total annual revenues.
MCHP’s mixed-signal microcontrollers (MMCUs) are the largest revenue source by product line, responsible for 57% of revenue, while analog chips supply 28% of the total. Within the geographic revenue mix, Asia is responsible for 46% of sales, Americas – for 29%, and Europe for 25%. The company’s large customer base and wide diversity of products ensure that no single customer or product has a significant influence on its financial results.
MCHP’s main products – MCUs and analog integrated circuits – are indispensable components of electronics, smartphones, vehicles, appliances, and other everyday-use devices. The company’s timely identification of megatrends such as 5G, the Internet of Things (IoT), data centers, autonomous vehicles, electrified transport, and sustainability, allows it to capitalize on these long-term tailwinds.
Although Microchip’s end-market demand is highly cyclical, the company’s efficiency and robust delivery, based on a solid business model, allow it to overcome the sales cyclicality, continuously expanding margins and registering multi-year earnings growth. MCHP has a long track record of stellar profitability through high and low parts of the sales cycle, with long-term upward trends seen in operating margins and free cash flows.
The whole semiconductor industry has seen a softening demand in 2023, which was first apparent in the PC and smartphone chip space but is now expanding to the industrial-focused chip niche. Analysts expect the current quarter to reflect the ongoing demand weakness, with the rebound part of the cycle arriving in the first or second quarter of 2024. Microchip’s long-term outlook remains intact, with the management penciling in annual revenue growth of 10%-15% through fiscal 2026.
Microchip Technology’s financial health is robust, despite its medium-high debt-to-equity ratio of 87%. Since 2018, the company has paid down almost half of its debt, which then amounted to over $11 billion, and now stands at $6 billion. MCHP’s debt is well-covered by operating cash flow, while the interest payments are covered by EBIT many times over. Besides, the company’s debt is highly rated by major rating agencies: “Baa1” at Moody’s and “BBB” at Fitch Ratings, representing the second-highest level of the ratings scope.
Particularly, in September this year, Fitch affirmed the company’s rating, applauding its “strengthened financial structure despite weakening demand conditions” and “ample financial flexibility.” In addition, Fitch said that “Microchip’s higher mix of in-house production amplifies revenue growth while structurally higher baseline revenue supports the company’s industry-leading profit margins.” The industry-leading results are driven by Microchip’s focus on faster-growing markets from increasing semiconductor content, particularly automotive and industrial, where the company holds the top-three market positions.
In the past three years, Microchip’s revenues have grown at a CAGR of 19.6%, while its EPS surged at a CAGR of 57%. Its stellar profitability is underscored by a gross margin of 68%, an FCF margin of 35%, an operating margin of 39%, and a net profit margin of 29%, all of which place it in the top 5% of its industry.
On November 2, MCHP reported its fiscal Q2 2024 (ended September 30, 2023) financial results. In the quarter, revenue and earnings-per-share were in line with analysts’ estimates for the second quarter in a row, after exceeding them in all previous quarters when these estimates were available. Fiscal Q224 was the 12th consecutive quarter of double-digit year-over-year EPS increases.
In its outlook for the current quarter, the management forecasted a decline in sales amid a turbulent macro environment and the ongoing down cycle in end-market demand. However, the projected gross, operating, and net profit margins are only marginally lower than those registered in FQ2. The management confirmed the company’s plan to return 100% of its free cash flow to shareholders in the form of dividends and share repurchases within approximately five quarters.
Analysts view the company as one of the best-managed in the semiconductor industry, with a proven ability to generate free cash flows under virtually any circumstances. This strength has supported the company’s capital allocation strategy, which includes generous dividend payments. Microchip has been paying dividends since 2002, increasing yearly since 2003. In the past three years, the company’s dividend-per-share rose at an average annual rate of 26%.
The latest dividend increase announcement came in the fiscal second quarter, when the management raised the payout by 34%, payable on December 6, 2023. MCHP’s current dividend yield is 1.8%, versus the Technology sector’s average of 1%.
Given Microchip’s low payout ratio of 25%, the more-than-sufficient coverage provided by its earnings, as well as the company’s stellar profitability and growth metrics, solid dividend-increase track record, and commitment to compensating its shareholders, MCHP is expected to continue delivering robust dividend-per-share growth in the years to come. Analysts expect that in the next years, dividends will grow at an average annual rate of 26%.
Microchip’s shareholders are also generously compensated via buybacks. The company has a share repurchase program in place, authorizing the management to purchase $4.0 billion of common stock. In FQ2, MCHP repurchased $339.8 million worth of shares, bringing the total amount of buybacks under the current program to $1.9 billion over the last eight quarters.
Taking into account outstanding operational delivery and shareholder compensation, no wonder that Microchip’s stock performance has been great, despite the cyclical volatility. In the past 12 months, MCHP’s stock has risen by 29%, outpacing the S&P 500’s (SPX) 23%. In the past three years, Microchip’s increase of 35% also beat the broad market’s gains of 27%.
Due to the cyclicality of the company’s business and, subsequently, of its topline results, and considering its recent surge which took it near its previous peak, the stock may be under some pressure in the next few months; however, longer-term it is expected to continue its strong performance. Meanwhile, it is trading under attractive valuations, with its TTM P/E of 20.2 and Forward P/E of 24.7 representing 27% and 13% discounts, respectively, to the IT sector averages. When compared to its industry peers, it comes at the lower part of the price range.
In conclusion, we view Microchip Technology as a compelling combination of quality and growth, while the company’s strong alignment with shareholder interests, reflected in its long dividend-increase history and robust share repurchase track record, presents MCHP as an attractive, long-term income opportunity for dividend investors.
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