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Morningstar | Microchip Should Outlast the Latest Round of Trade Tensions; Maintain $112 FVE, Shares Undervalued

Microchip Technology reported solid fiscal fourth-quarter results in light of a sluggish demand environment for the firm's microcontrollers and analog semiconductors. The company's outlook for the June quarter was a bit soft, as the heightened risk this week of a prolonged trade war between the U.S. and China has given Microchip some hesitancy in pronouncing a chip demand recovery. Looking at the long term, we still think Microchip is well exposed to secular trends of rising chip content per automobile and the Internet of Things. We continue to view wide-moat Microchip and its exemplary management team as well positioned to weather virtually any economic storm, and we remain optimistic about both long-term organic revenue growth and synergies associated with its acquisition of Microsemi last year. We will maintain our $112 fair value estimate for Microchip and continue to view the firm as undervalued and one of our best investment ideas within the tech sector.

GAAP revenue in the March quarter was $1.33 billion, down 3% sequentially, up 33% year over year (mostly due to contributions from Microsemi) and at the midpoint of the firm's updated forecast as announced in early March. Microchip believed that March would be a bottom in the latest chip industry cycle, "barring any negative development" on the trade front, but unfortunately, recent rhetoric suggests that such negative developments may come to fruition shortly in the form of higher tariffs on Chinese products. We note that end market demand (i.e., sell through revenue to end customers) was down 16% sequentially in Microchip's Asia region (including China), offset in part by 14% growth in Europe and 3% in the Americas.

For the June quarter, Microchip expects GAAP revenue to be flattish at $1.33 billion, plus or minus 5%, which is worse than the growth Microchip normally sees in the seasonally strong June quarter. Management indicated that it has, on average, seen 3% revenue growth over the past seven years, excluding the firm's various acquisitions.

We suspect the soft outlook stems from recent rhetoric this week about heightened trade tensions between the U.S. and China. Management conceded that it would have provided investors with a higher guidance midpoint, as well as a narrower range, if commentary this week from the U.S. government did not occur. Thus, we suspect that if the U.S. and China were to resolve their trade issues quickly and adequately, Microchip's June outlook could potentially turn out to be conservative.

Microchip actually started to see a pickup in demand from China subsequent to the March quarter-end, although such pickup occurred before the recent round of rhetoric this week. Automotive chip demand remains weak due to worldwide sluggishness in auto sales, yet Microchip also believes this business bottomed in the March quarter and the firm expects demand to strengthen in the second half of calendar 2019.