Looking for a bullish semiconductor bet? MCHP isn’t it

As trade tensions have restored volatility to the market, sectors like Industrials and Technology appear to be on the bleeding edge of risk exposure. That’s because the longer tariffs remain in place – and both the U.S. and China keep drawing their own respective hard lines in the sand about trade – the more the effects increased costs from those tariffs will have their way on stocks in those sectors. Semiconductors, in particular have been taking it on the chin over the last few days – as measured by the Philadelphia Semiconductor iShares ETF (SOXX), the industry is down about -9.5% in the last week.

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In the short term, volatility means risk is increased, and it makes it harder to make even an educated guess about which direction a stock is going to go. At the same time, it can also created opportunity for patient, long-term investors, who are willing to wait for fundamentally strong stocks to retreat to attractive valuation levels. When it comes to semiconductors, I like working with the companies that provide products and services to the industry. These are names that the average investor generally doesn’t know about, but that generally have a global footprint and a large customer base to work from.

Microchip Technology (MCHP) is a good example of these kinds of stocks. It is true that semiconductors, including service providers, generally have a large exposure to China, which means that they have been particularly sensitive to trade pressures. In MCHP’s latest earnings release, for example, the management cited Chinese tech giant Huawei as a headwind that had a negative impact on their results in the quarter due to the company’s blacklisting by the U.S. government. Tariffs in general have also been acting as a significant headwind. Trade, along with their earnings report have all weighed on the stock over the last two weeks, pushing it about -15% off of a short-term peak at around $100. Are the fundamentals still strong enough to warrant taking a long-term position on this stock? Let’s take a look. 

Fundamental and Value Profile

Microchip Technology Incorporated is engaged in developing, manufacturing and selling specialized semiconductor products used by its customers for a range of embedded control applications. The Company operates through two segments: semiconductor products and technology licensing. In the semiconductor products segment, the Company designs, develops, manufactures and markets microcontrollers, development tools and analog, interface, mixed signal and timing products. Its functional activities include sales, marketing, manufacturing, information technology, human resources, legal and finance. Its product portfolio comprises general purpose and specialized 8-bit, 16-bit, and 32-bit microcontrollers, a spectrum of linear, mixed-signal, power management, thermal management, radio frequency (RF), timing, safety, security, wired connectivity and wireless connectivity devices, as well as serial electrically erasable programmable read-only memories (EEPROMs) and serial flash memories. MCHP has a current market cap of about $20.2 billion.

Earnings and Sales Growth: Over the last twelve months, earnings have grown about 2.25%, while revenues increased almost 33%. In the last quarter, both numbers were negative, reflecting the impact of tariffs as already mentioned, and of the work the company still needs to do to improve their bottom line. The company’s margin profile over the last twelve months showed Net Income was about 6.76% of Revenues over the last twelve months, but narrowed to 3.53% in the last quarter. When you consider that this is a pattern that has persisted over the last three quarters for the stock, I consider this to be a pretty big red flag, indicative of broader pressures that may not dissipate anytime soon.

Free Cash Flow: MCHP’s free cash flow is solid, but declining, at more than $1.44 billion – down from $2.77 billion earlier in the year. This number translates to a Free Cash Flow Yield of 7.14% but was nearly 14% two quarters prior.

Dividend: MCHP’s annual divided is $1.46 per share and translates to a yield of about 1.7% at the stock’s current price.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MCHP is $20.38 and translates to a Price/Book ratio of 4.17 at the stock’s current price. This is another sign of declining fundamentals in my opinion, since it is also marks a decline from the beginning of year, when MCHP’s Book Value was $21.82. The stock’s historical average Price/Book ratio is 4.62, which puts a target price for the stock at about $94 per share, or just about 10.5% above its current price. Considering the fundamental weakness the company is grappling with, and the trade issues that aren’t going away anytime soon, this isn’t enough to make a compelling argument.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s upward trend from June to November of last year to its peak in May, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock’s decline from a high at around $101.50 is hard to miss; in particular, the stock’s rapid, steep drop from a peak at around $99 from late July to now means the stock is dealing with massive bearish sentiment and momentum right now. The last few days have pushed the stock below the 38.2% retracement line, which means that it could start acting as a significant level of resistance in the near-term. The stock’s next most likely support level is between $76, where the 61.8% retracement line sits, and $79 where the stock formed a pivot low in late May.

Near-term Keys: If you’re willing to be aggressive, a push above the 38.2% retracement line, to about $86.50 could mark an opportunity to work with call option or to buy the stock with a near-term price target at around $92 per share. Given the strength of the stock’s current bearish move and momentum, however, that is a very aggressive trade. If the stock breaks the support it has found in the last couple of days at $83, you’ll see a higher-probability signal to think about shorting the stock or working with put options, with a target price between $79 and $76 to close that trade. Until the company shows signs of improving its fundamental problems – specifically, reversing its pattern of deteriorating Net Income, declining Free Cash Flow, and lower Book Values – I don’t see any reason to take MCHP seriously as a long-term opportunity.

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