When people hear the word “semiconductors” today, they think of companies like Nvidia Corp. (NVDA) or OpenAI. Artificial intelligence has helped drive the recent tech bull run… and it’s semiconductors – powerful ones – that drive AI.
This is a big reason why Nvidia has become a $1 trillion company, the sixth-largest in the world, over the past month.
But the intense, hyper-focus on AI (and Nvidia for that matter) puts investors at risk of missing out on trillions more lying on the table.
The truth is there are five other digital megatrends taking off alongside AI: autonomous driving and the “Internet of Things” among them. More on those in a moment.
The stock I’m going to name right now costs less than one-fifth the price of one share of NVDA, but it gets your portfolio squarely in the middle of these world-changing, wealth-generating trends.
There’s Much More to Chips Than Just Nvidia
While Nvidia is building the graphics processing units (GPUs) that run AI software, there are hundreds of other semiconductors in the supply chain, all of them as critical as GPUs.
That’s why Microchip Technology Inc. (MCHP) is one of my favorite semiconductor stocks right now.
They don’t provide just one component, but what they call a “total system solution”; they provide many parts of the solutions that a customer requires.
Microchip Technology is a leading provider of microcontrollers, mixed-signal, analog, and Flash-IP integrated circuits (ICs) has its products used in a wide variety of products, including automotive and aerospace, industrial, consumer, and networking.
Simply put, Microchip creates smart and connected products that help make modern “things” work and are deployed across dozens of industries. They provide the essential parts and technology that make innovations possible.
I’ve got two examples below – a car and a plane. Let’s look “under the hood” at Microchip…
Microchip Makes the Modern World Go
Below is a Hyundai Ioniq 6, a new car that recently won the 2023 World Car of the Year award. This car is a complex machine in which advanced electronics and mechanical parts must work together flawlessly under extremely stressful conditions. Microchip Technology provides no fewer than 88 different components spread across the “system” that is a modern automobile – computing, analog, networking, security, and wireless. And you can take any car from any part of the world… and inside it you’ll find something, often many things, from Microchip.
We could do this again with an airplane – a machine that, obviously, is much larger and more complex than a family car. And you can see Microchip products present in the different systems within the aircraft. In an average commercial aircraft, whether it’s made by Boeing Co. (BA) or Airbus SE (EADSY), you’re going to find about $100,000 worth of Microchip’s products.
This “Total Systems” strategy – executed in a world overwhelmingly and increasingly reliant on all sorts of semiconductors – has led Microchip Technology to experience massive growth in recent years.
Let’s take a closer look at the big trends powering this company
And Here’s What’s Makes Microchip Technology’s Growth Go
Microchip Technology has diversified their products to the point where they’re in several different end markets served by the 21st century’s great “megatrends.”
The first of them is 5G infrastructure, we’re into the third or fourth year of a 10-year journey, there’s a long journey – and billions more in upside – ahead of us. At the destination is powerful high-speed mobile communications from coast to coast.
The second is the Internet of Things (IoT) and edge computing; AI and machine learnings (ML) play a huge role here. We’re already living in a world in which your kid’s toothbrush can send you an SMS text message telling you whether they’ve brushed for two minutes, or where your toaster simply won’t permit your waffles to get burned. You can control entire home security and climate controls from your pocket. The IoT is just getting started.
The third unfolding megatrend is “e-mobility,” which is a catch-all phrase for electronic vehicles (EVs) like cars, bikes, busses, and scooters. We have ambitious decarbonization goals to meet, and the EV rollout will require an immense buildout of charging stations, sensors, and the like. They will all have to be “smart,” too.
And this brings us to the fourth megatrend: sustainability. There’s a huge effort underway across virtually the entire planet to reduce energy consumption, carbon and pollution, water usage, and much more. To accomplish this, humans and their devices are going to need to be smart – Microchip has the devices covered, at least.
And finally, the fifth megatrend: autonomous driving. We can include the new driver assistance features in this. Many modern cars will tell you whether or not you’re leaving your travel lane, or whether there’s a vehicle in your blind spot. The newest cars can measure your eye motion and gauge your alertness on long trips, and helpfully suggest it might be time to pull over for a cup of coffee or a hotel.
Every single one of these requires semiconductors to enable connectivity and communication, and their advanced functions will quickly come to rely on AI and ML. Many of them already do.
From Under the Hood to On the Books: Microchip Is in Great Financial Shape
Given the company’s diversification, they are an extremely durable business. Below is a chart of the boom and bust semiconductor industry cycle.
A lot of investors either deny or don’t realize that semiconductors are very much a cyclical industry these days.
This is a chart of Microchip’s performance throughout business cycles – it’s a 15-year picture of stability and growth.
Microchip has been able to keep up is gross margins and hence increase its free cashflow. Over the last 10 years, they have grown their adjusted free cash flow at a 23.4% compound annual growth rate (CAGR). They have also decreased their net leverage – from 4.77x in 2019 to 1.45x – for the full year 2023. This is a great example of a resilient business.
Revenue growth has also seen a significant re-acceleration over the last two years, to the point where Microchip Technology is estimated to grow its revenue 16.5% year over year next quarter.
The Bottom Line: Microchip Technology Is a “Buy”
In my view, Microchip Technology stands out as one of the most diverse semiconductor companies and its growth trajectory shows just how adaptable they are to today’s market. Through smart acquisitions and organic product introductions, they have positioned themselves for growth and profits as the future technology curve takes shape.
Of course, it helps that they also have a compelling valuation compared to their competitors. Microchip is trading at 11.2x enterprise value/EBITDA, while Texas Instruments Inc. (TXN) and Analog Devices Inc. (ADI) are both trading above 16. In fact, the Philadelphia Stock Exchange Semiconductor Sector (PHLX) as a whole is trading at 15.6.
The dividend is modest, which is not out of line with a lot of tech firms, but it is there: the stock currently yields a 1.9% payout – a small cherry on top of a very big sundae.
Director of Technology Investing Research, Money Map Press