Microchip Technology: High Debt, Expensive Stock

Microchip Technology, Inc. (MCHP) is a leading provider of smart, connected, and secure embedded control solutions. The company’s solutions serve more than 120,000 customers across the industrial, automotive, consumer, aerospace and defense, communications, and computing markets. Microchip Technology Inc. was founded in 1989 and is headquartered in Arizona.

I am bearish on MCHP stock. The company has a high level of debt, and the stock is expensive. It has one-year gains of approximately 9.8% and has underperformed the S&P 500. At the same time, the forward dividend yield of 1.17% is moderate and almost in line with the current yield of 1.30% for the S&P 500.

Microchip Technology Business News

Microchip Technology has announced “the LAN9668 family of TSN switching devices, delivering IEEE standards-compliant features in the industry’s first switching solution enabling lower latency data traffic flows and greater clock accuracy.”

This new family of Ethernet switches, according to the firm, boast features such as reducing “system cost and risk for designers while speeding time to market.”

The company has also announced that “Space system designers cannot easily support non-standard voltages or add functions with traditional hybrid-style power converters. Microchip Technology Inc. has eliminated the cost, complexity, and customization challenges of these hybrid solutions by offering a discrete-component-based, space-grade DC-DC power converter family that now includes 28V-input, 50-watt radiation-tolerant options.”

It is also notable that Microchip Technology announced that it significantly expanded its Gallium Nitride (GaN) Radio Frequency (RF) power device portfolio with new MMICs and discrete transistors that cover frequencies up to 20 gigahertz (GHz).

“The devices combine high power-added efficiency (PAE) and high linearity to deliver new levels of performance in applications ranging from 5G to electronic warfare, satellite communications, commercial and defense radar systems and test equipment,” the press release stated.

Microchip Technology has a wide range of products ranging from data converters, memory products, power management, RF, motor drivers, and more. At the same time, its solutions apply to a vast number of industries, such as aerospace & defense, automotive & transportation, embedded security, industrial, and the internet of things.

Fiscal Q2 2022 Earnings

Microchip Technology ends its fiscal year at the end of March. The latest quarter’s earnings were mixed. Normalized EPS of $1.07 was a beat by $0.01, but GAAP EPS of $0.43 was a miss by -$0.07. Revenue of $1.65 billion was a beat by $138.5K.

MCHP stock earnings present stable and consistent growth. It is very positive that the company has a beat on EPS for the past eight consecutive quarters.

For the three months ended September 30, 2021, Microchip Technology reported a gross profit of 1,068.3 million, operating income of $416.3 million, and net income of $242 million. These numbers were all higher year-over-year.

Fundamentals – Risks

I see several risks for MCHP stock that raise major concerns. The cash-to-debt ratio, which measures the financial strength of a company, was only 0.03 during the last quarter. This is too low, signaling potential problems for the firm to pay off its debt using the cash on its balance sheet. The company has a high level of debt, with a debt/equity ratio of 1.44 as per last quarter.

The interest coverage ratio of 4.5 is safe, but the debt-to-EBITDA ratio of 3.3 is also considered high. Microchip Technology Inc’s operating margin is expanding, which is a positive sign, but there are other warnings to look out for. Some examples include the dividend payout ratio of 0.71, which is too high in my opinion, and revenue growth that has slowed down over the past 12 months.

Its financial leverage of 2.84 per latest quarter is also high, but it has been reduced over the past two consecutive fiscal years. Notably, shareholders have been diluted in the past year, with total shares outstanding growing by 6.6%, which is bad news for valuation.

I estimate that the firm will try to lower its financial leverage and reduce interest expense, improving profitability.

Valuation

MCHP stock is relatively expensive based on its P/E ratio of 66x compared to the U.S. semiconductor industry average of 24.7x and the U.S market average of 16.2x. Its PEG ratio of 1.4x is also considered high.

Wall Street Take

Microchip has a Strong Buy consensus based on 13 Buys and three Hold ratings. The average Microchip Technology price target of $100.69 represents 33.6% upside potential.

Conclusion

Microchip Technology has improved its profitability on a TTM basis, and it generates solid positive free cash flows. However, the company has a high level of debt, and the stock is relatively expensive. Therefore, I am bearish.

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