Microchip Tips Broader Strength (MCHP: BUY, $41 target)

Recap: Microchip continued to see strong demand through the March quarter (and into April) and this helped it top consensus estimates (and ours) delivering $0.52 in EPS (vs. $0.47 expected) on $430.1M in sales (vs. $426.9M expected). Bookings have remained strong since the year’s beginning and internal inventories have dropped back to normal even as channel inventories have recovered since the December low. Backlog to begin the June quarter exceed that of March and stretches into the September quarter.

Guidance points to 2-6% sequential revenue growth, and EPS guidance of $0.50-$0.54 meets our prior forecast, but is ahead of consensus. The strength this quarter comes not only from strong demand, but also from a boost in gross margin—ahead of expectations—and additional accretion from SMSC as the company uncovers yet more sources of cost savings.

We continue to recommend the shares and see room for continued outperformance based on further share gains, economic rebound, and further margin expansion (and, of course, that appealing dividend). We also see upside from Microchip’s report for other broad-based semi providers.

Beyond Microchip, the bookings strength sheds a bit of light on the mixed global macroeconomic data. With its broad exposure to sectors outside of consumer electronics, Microchip’s momentum points to a groundswell of economic activity; likely propelled by improving U.S. housing conditions, continued strength in automotive, and ongoing (if cautious) investments in industrial infrastructure around the world. Much of the strength at Microchip, however, likely comes from new design wins and share gains in the newer 16- and 32-bit MCU product lines. The company did not break out the core products as compared to the newer ones, but the share gains reported reveal that Microchip’s growth is well ahead of the market as a whole.

This helps to explain the relative strength of Microchip’s commentary compared to that of some other broad-based semiconductor providers, but jibes with TI’s guidance for 8.5% sequential growth (excluding the terminated wireless business). While both these companies appear to be share gainers, they also seem to be tapping into global macro recovery.

Several companies, reporting earlier, noted limited visibility to orders (including RI) so the April data from Microchip provides some support to the view that strength for broadly exposed semi providers is also continuing. Look for Avago (AVGO) to offer guidance ahead of expectations for its July quarter. This bodes well for Linear Technologies (LLTC) and, if trends continue as they are, suggests that June may already be trending to the upper half of guidance.

Savings: Operating expenses came in below target from strict spending discipline across the company and greater savings through the integration of SMSC. Look for OpEx to grow more slowly than revenues through CY13. We expect gross margin expansion and spending controls to enable (non-GAAP) operating margin to rise from last quarter’s 28.6% to 27.6% by the March 2014 quarter.

Minor Changes to Our Above-Consensus Estimates: Guidance is roughly in line with our prior views, and we expect:

• F1Q14 revenues of $448.3M and non-GAAP EPS of $0.53.
• FY14: $1.871B and $2.28.

Stay the Course: Reiterating BUY and $41 target.  Microchip’s momentum continued into April and gross margin has begun recovering ahead of schedule. The SMSC acquisition continues to deliver greater accretion than forecast and that combined with share gains in MCUs points to the likelihood that Microchip will continue to outperform other MCU suppliers and broad-market analog semiconductor companies. Factory staff furloughs are being trimmed, wafer starts are picking up, and backend processing capacity is expanding. All this, we believe, points to rising operating margins through CY13.