Here’s What Makes Microchip Technology Stock A Strong Semiconductor Play

We think that Microchip Technology Inc. (NASDAQ:MCHP) currently is a better semiconductor technology bet compared to Texas Instruments Incorporated (NASDAQ:TXN). MCHP stock trades at 8.1x trailing revenues, lower than that of TXN, whose P/S multiple stands at 10x. Does this gap in the companies’ valuations make sense? We don’t think so and we expect Microchip Technology to close this gap. While both companies weren’t significantly hampered by the pandemic, MCHP has seen more rapid sales growth over the past five fiscal years than TXN. Microchip’s revenues have grown nearly 2x since FY ’17 (MCHP’s fiscal year ends in March) and currently stand at $6 billion on an LTM basis. At the same time, TXN’s sales first rose from $13.4 billion in FY ’16 to $15.8 billion in FY ’18, before pulling back to around $14.5 billion in FY ’20. However, Texas Instruments’ sales have recovered since, and currently stand at $17.6 billion on an LTM basis. For details about TXN revenues and comparison to peers, see Texas Instruments Incorporated (TXN) Revenue Comparison.

Having said that, we dive deeper into the comparison, which makes Microchip Technology a better bet than Texas Instruments, at these valuations. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at detailed historical revenue growth as well as operating income growth and financial position, combined with expected returns. Our dashboard Microchip Technology vs Texas Instruments: Industry Competitors, But Microchip Technology Is A Better Bet has more details on this. Parts of the analysis are summarized below.

1. Microchip Technology Ahead On Revenue Growth

Microchip Technology has witnessed much faster and more consistent revenue growth over the years. MCHP’s sales have jumped from $3.4 billion in FY ’17 to $6 billion on an LTM basis, while Texas Instruments saw a more inconsistent growth over this period, with sales rising only 30% in comparison from $13.4 billion in FY ’16 to $17.6 billion currently.

Additionally, MCHP’s pre-Covid annual sales growth stands at 20.4%, multiples higher than TXN’s 2.8%, but growth during Covid, stands slightly lower at -1.4%, compared to TXN’s marginal 0.5%. However, a look at recent trends reveals that Microchip witnessed 26% YoY and 5.1% QoQ sales growth for its most recent quarter (Q2 ’22), compared to TXN’s 21.6% and 1.4% respectively.

Finally, last three FY sales growth for Microchip stands at 12%, much more than TXN’s -0.9%.

2. EBIT margins And Financial Position: Texas Instruments Ahead

Microchip’s P/EBIT ratio stands at around 48x currently, more than double that of TXN’s 21.3x. However, Microchip’s LTM EBIT margins currently stand at 17%, much lower than TXN’s 47%, and Microchip is also slightly behind in terms of LTM margin change compared to the last three fiscal years, with 4.3% growth vs TXN’s 6%.

Additionally, Microchip’s debt as a % of equity stands at 17.2% currently, much more than TXN’s 4.4%. TXN is also ahead in terms of cash as a % of assets, with 42%, much higher than Microchip’s 1.6%. However, these numbers can be attributed to the fact that Microchip is still in its growth phase, compared to Texas Instruments, a more stable company (as can be seen from the gap in revenue growth numbers).

For additional details about Microchip’s historical returns and comparison to peers, see Microchip Technology (MCHP) Stock Return.

3. Finally, Microchip Is Ahead In Terms Of Expected Returns

Using P/S as a base, due to high fluctuations in P/E and P/EBIT, we believe Microchip is the better choice. Microchip’s LTM revenues of $6 billion are expected to rise at a CAGR of almost 19% as per our estimates, taking revenue numbers three years out to as high as $10 billion. Assuming Microchip’s P/S ratio to pull back to around 6x, this still means that the market cap would rise to $62 billion, an upside of nearly 30% over three years.

In comparison, given historical trends, we expect Texas Instruments’ sales to rise slower at a CAGR of just 1.6%, taking revenue in three years to a little over $18 billion. However, considering the P/S for Texas Instruments to drop at a slower rate to 9x, we still estimate a market cap of $168 billion for Texas Instruments, roughly 5% lower than the level it is at today.

The Net of It All

Despite Texas Instruments’ revenues being larger than that of Microchip’s, the latter has seen faster and more consistent revenue growth lately, but is still in a growth phase and has much lower margins than Texas Instruments. Having said that, our comparison of the post-Covid recovery above, shows that Microchip has shown stronger sales growth than Texas Instruments, and we believe profitability will catch up soon enough. Due to this, we believe that Microchip deserves a higher P/S multiple, and we expect MCHP to close the current gap in valuation between the two companies. As such, we believe that Microchip Technology stock is currently a better bet compared to Texas Instruments stock.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio that’s beaten the market consistently since the end of 2016.

[1] Month-to-date and year-to-date as of 1/9/2022
[2] Cumulative total returns since the end of 2016