Microchip Technology: Challenges for Chip Makers Ahead?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Microchip Technologies (NASDAQ: MCHP) is one of the leading manufacturers of specialized computer chips.  It has also been one of the best ways to get exposure to the tech sector in a dividend portfolio, having rebounded nicely from its 2009 low of $16.23 to its current price of $33.53 as of this writing.  It also pays an extremely nice dividend for a tech company, yielding 4.2% and steadily rising.  With the company set to report earnings next Monday, investors will be on the lookout for signs of future growth by the company.

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Microchip Technology is a leading microcontroller company (MCU), having shipped over 7 billion since 1990.  MCU’s are low cost chips that form the “brains” of most electronic devices that are not personal computers, and the company manufactures a broad line of 8- and 16-bit programmable microcontrollers, which account for 68% of the company’s sales, with the rest coming from memory products (13%), analog products (12%) and technology licensing (7%).  Unlike most rival U.S. chip makers, the vast majority (82%) of the company’s sales come from international customers, with 56% coming from Asia. 

Microchip Tech has stated that their goal is to be the worldwide leader in specialized semiconductor products for embedded control applications.  The company currently is the market leader in the 8-bit market, and is trying to gain ground in the 16- and 32- bit markets also.  During the earnings call, any positive updates in these areas would be welcome news for investors.  Also, the company acquired Standard Microsystems in August, which is expected to account for 20-25% of Microchip’s revenue going forward, expanding the company’s offerings in the automotive and wireless audio segments.  This most recent quarter will be the first where this acquisition is completely included in the results, so anything the company has to say about the impact of Standard will be influential to investors one way or the other.

The general consensus seems to be that expenses for chip makers will grow slightly faster than sales, with industry analysts projecting operating margins of 28% in fiscal year 2013 (which ends in March), falling to 24% in FY 2014.

The company is projected to earn $1.77 per share for the current fiscal year, which is expected to grow to $2.05 for FY 2014 and fall slightly to $2.04 for FY 2015 due to the aforementioned margin concerns.  Although the current valuation of 16.4 times forward earnings seems high, it looks slightly better when excluding the company’s $1.1 billion in net cash (13.6 times forward earnings).  However, I would need to feel confident that the margin concerns are merely temporary before I would make an investment in Microchip Technology.  For my money, rival chipmaker Intel (NASDAQ: INTC) seems like a better play at the moment.  Even though the market has the same concerns about margins going forward, and they are projecting a similar earnings pattern (growth from fiscal years 2013-2014 and flat going into 2015), Intel only trades at 9.97 times TTM earnings, a big difference from Microchip.  If growth is what you’re after, rival chip maker Altera (NASDAQ: ALTR) trades at 20.3 times earnings, which are projected to grow considerably better over the next several years.  However, this high multiple makes me nervous.

The bottom line is that I am not sold on any of these chip makers until they can address some of the concerns about profitability going forward.  Although the 4.2% dividend and solid balance sheet are tempting, I will not be bullish on Microchip Technology until they show the market a plan on how they will grow over the next several years despite the challenges they face.

KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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