MX - Magnachip: This $7 Stock Could Be The Biggest Bargain In The Chip Sector

2023-12-31 23:43:00 ET

Summary

• Buying undervalued stocks during tax-loss season can lead to big gains into the New Year.
• Buying tech/chip stocks at or near cyclical lows can also generate big profits.
• Magnachip Semiconductor appears to have hit rock-bottom levels and could rebound significantly in the coming upcycle.
• This company has a cash-rich balance sheet and a significant share buyback plan, plus insiders have recently bought shares.
• I am Hawkinvest. For many years I have been researching and writing about contrarian buying opportunities that can create outsized portfolio gains.

At this time of year, I like to focus on stocks that could be due for big gains into the New Year, especially as tax-loss selling fades. In particular, it can pay off big to find beaten-down tech stocks. In past years, I wrote an article about Advanced Micro Devices ( AMD ) when it was trading for about $3 per share. I wrote an article at the end of 2020, on Aehr Test Systems ( AEHR ) when it was trading for just over $1 per share, and it went on to trade for around $50 per share. These types of gains can make life-changing impacts on a portfolio, so I am compelled to keep looking for more opportunities like this. It's not easy to do because when these stocks were trading for the low single digits, hardly anyone seemed to want to buy these stocks. My articles on these stocks did not get much attention or many comments. But that is exactly why buying down but not out tech stocks can be so incredibly rewarding. It can really pay off to buy when investors have given up on tech stocks that still have significant upside potential. It's important to remember that almost all chip stocks traded at single digits at some point, which includes names like NVIDIA Corp (NVDA), which was just around $6 per share in 2016. With this in mind, let's take a closer look at a beaten-down tech stock that could be poised to surprise to the upside in the coming months and years:

Magnachip Semiconductor ( MX ) designs and manufactures semiconductors for various markets including automotive, industrial, computing, IoT, communications, and other applications. It owns a significant patent library and just a couple of years ago, it was a takeover target at $29 per share, however, the deal was blocked due to national security concerns.

The Chart:

As you can see in the chart above, this stock has had a couple of runs to over $20 per share in the past several years and it has also bottomed out around the $6 range more than once. In the past couple of weeks, Magnachip shares have started to rise and could soon be heading back to the 200-day moving average which is around $8.63 per share. However, more patient investors could see this stock back in the $20 per share range as the chip industry appears poised for a new upcycle thanks to AI and other factors. There are also plans to separate Magnachip into two entities, which could lead to gains for shareholders.

Revenues, Earnings, And A Cash-Rich Balance Sheet:

According to analyst estimates , Magnachip Semiconductor is expected to generate about $231 million in revenues for 2023, with a solid increase to $279 million expected in revenues in 2024. But the big jump in revenues is expected in 2025, as analysts expect sales to surge to about $370 million, fueled by new products and a new upcycle in the chip sector. At that point, it would appear likely for this company to be earning well over $1 per share again, as it has done historically . This could be what shareholders need for the stock to be trading around $25 per share again. In 2017, this company earned about $1.59 per share, and it earned $1.23 per share in 2020, and $1.19 per share in 2021, so it has a history of this level of earnings in good years.

For Q3 of 2023 , this company came close to posting breakeven results, with a non-GAAP loss of just 4 cents per share and a GAAP loss of 13 cents per share on revenues of $61.2 million. The company also stated it had brought back $5.4 million worth of shares and said it ended the quarter with $166.6 million in cash and no debt. This extremely strong balance sheet gives the company the flexibility to invest in new product R&D and to keep buying shares. It also reduces risks for shareholders.

The Past Buyout Offer And Upcoming Separation Of Magnachip:

In 2021, Magnachip Semiconductor received a buyout offer for $29 per share in cash from Wise Road Capital, Ltd. (which is a private equity firm that focuses on technology). The deal was terminated in late 2021 because in spite of efforts by both parties, they were unable to receive approval from the Committee on Foreign Investment in the United States or "CFIUS". Had it gone through, this deal would have been great for shareholders, however, I think the main takeaway at this point is that this shows what the value of this stock could be during the next upcycle. It's also worth noting that it looks like we are heading into the next upcycle now. This is based on inventory reductions that are being seen at a number of chip firms like Micron (MU). It is also based on a general uptrend in the share price for many chip companies. As part of this upcycle, analysts are expecting a big jump in revenues for Magnachip in 2025.

The $29 per share all-cash buyout deal being blocked by CFIUS, may have led Magnachip to make a strategic decision to separate their power and display businesses into two businesses. This strategic move is expected to be completed sometime in the fourth quarter of 2023. This might allow Magnachip to sell one of these businesses without the same CFIUS concerns, and this could create shareholder value.

A Rising Tide In AI and Chips Could Lift All Boats Including Magnachip:

There are many recent developments that are expected to create strong demand for the chip sector and one of the biggest is AI. Also, coming in 2025 is the fact that Microsoft ( MSFT ) will end support for the Windows 10 operating system on October 14, 2025. These major factors, plus the upgrade cycle for other tech products from companies like Apple ( AAPL ) are going to drive increased demand. The Semiconductor Industry Association is forecasting double-digit growth for the chip sector in 2024. Just days ago, UBS ( UBS ) stated that the chip sector was going to be in the "sweet spot" starting in 2024, and a Seeking Alpha article regarding this bullish outlook said:

"Delving deeper, UBS said the inventory cycle in the chip space has peaked and is coming down, though memory is still high. Additionally, as rates come down, downstream demand pull should strengthen and revenue growth should "materially" outpace inventory growth next year, a scenario that has been a positive backdrop for the last four chip cycles."

Other research firms and analysts are also seeing the start of a very bullish backdrop for chip stocks thanks to the PC refresh and upcoming demand for AI-compatible devices. A recent CNBC article states:

“At the end of a difficult year for the PC market, there is finally reason for optimism. Canalys expects the PC market to return to growth of 8% in 2024 as customers look to refresh the PCs of the pandemic era and new AI-capable devices emerge,” said analysts Ben Caddy and Kieren Jessop in a Dec. 20 report .

Microsoft ending support for its Windows 10 operating system on Oct. 14, 2025, in line with its normal 10-year support lifecycle “could prevent hundreds of millions of devices from getting second lives,” Canalys said, which will further drive sales of newer PCs."

“The integration of AI capabilities into PCs is expected to serve as a catalyst for upgrades, hitting shelves in 2024,” they added.

Dirt Cheap Valuation:

There are many factors that suggest Magnachip is deeply undervalued, just as other chip stocks I bought in the past were. Let's take a look at these top reasons as to why Magnachip appears deeply undervalued:

1) One major valuation point to reflect on is the buyout offer at $29 per share, which was just a couple of years ago. This valuation shows where Magnachip could be worth during the next upcycle.

2) Historical earnings and potential earnings estimates of around $1.20 to about $1.60 per share could mean this stock is trading currently for less than 5 times its peak historical earnings.

3) Historically, this stock has bottomed out at around $6 to $7 per share, and this is shown on the chart as being the point where the stock is undervalued.

4) Magnachip has a current market cap of less than $300 million. When you consider the nearly $167 million in cash it has on the balance sheet, this equates to an enterprise value of just around $130 million. Taking an enterprise value of just $130 million and comparing it to 2024 revenue estimates of roughly $280 million and 2025 revenue estimates of $370 million, shows that this stock has significant upside potential. That's because most chip stocks trade for a multiple of their revenues, and Magnachip has also done this in the past. However, right now it is trading for a price-to-sales ratio of just around .5, and this is very undervalued compared to the chip sector and to the valuation it held during the $29 per share buyout.

Buybacks And Insider Stock Purchases:

Some companies authorize share buybacks but then do not buy shares or buy very little. However, Magnachip management is putting their money where their mouth is by actually buying shares for themselves and also completing significant share buybacks and authorizing new buyback agreements. In August 2023, the company said it completed a previously authorized share buyback by purchasing $25.5 million worth of shares in Q2 of 2023. Plus, it authorized a new $50 million share buyback.

As mentioned above, a couple of insiders recently purchased shares for themselves. On December 8, 2023, Nathan Gilbert , (director), purchased 10,000 shares at $6.80 per share. He also purchased 10,000 shares in August 2023, for $8.39 per share. After these purchases, Mr. Gilbert owns about 78,200 shares. Also on December 8, 2023, Martino Camillo , (director), purchased 10,000 shares at $6.80 per share. After these purchases, Mr. Camillo owns about 154,715 shares.

Magnachip Shares Appear Poised For A January Effect Rally:

There are a few reasons why I expect Magnachip shares to rally in January. One reason is that beaten-down stocks that have been under pressure from tax-loss selling tend to rally in January, as the tax-loss selling pressure ends completely. Also, short sellers often wait until early January to cover short positions because by doing so they can postpone the gains for another calendar year (instead of covering now which would result in taxes being due for 2023). Short covering could spark more gains in January for Magnachip shares. According to Shortsqueeze.com there are nearly 700,000 shares short and this represents almost 3 days' worth of average trading volume.

Finally, Magnachip shares could rally into January because small caps like Magnachip appear poised to outperform in 2024. Many analysts have recently turned bullish on small-caps and expect large gains in 2024. Famed analyst Tom Lee, head of research at Fundstrat, is bullish on small-caps and points out that " Small-caps on a P/B are at 1999 lows, the launch point for a 12-year outperformance cycle".

Potential Downside Risks:

I feel that with this company getting through what appears to be the bottom of the chip cycle, and with it having a very cash-rich balance sheet and no debt, the downside risks are very limited with the stock trading for just over $7 per share. With every tech stock, there is the risk that the products they make will become obsolete or be slowly diminished due to competitive pressures. I believe this is the biggest threat to any tech company, including Magnachip. However, this company has been around for decades and it has risen multiple times along with the cycles in the chip sector. Management decisions to buy shares for their personal accounts and to authorize significant share buybacks could also be viewed as a reason to believe that potential downside risks are limited at this level.

Like any semiconductor company, Magnachip faces risks from competitors, regulators, and macroeconomic risks. We've already seen regulators foil the planned buyout of Magnachip and the United States is increasing regulations and bans on chip sales to countries like China . However, the types of chips currently made by Magnachip do not appear to be at high risk for major regulatory changes. As for the macroeconomic risks, the outlook for 2024 appears to be strong for the chip sector and the economy in general. But, if the soft landing is not successful, due to long lag times for Fed policies, we could see a mild recession that delays the expected upcycle for chip companies. Many tech analysts see AI as being the fourth industrial revolution , so if there is general economic weakness in the global economy, the expected boom in AI-related industries might offset this weakness regardless.

In Conclusion:

As my previous articles on Aehr Test Systems and Advanced Micro Devices show, buying chip stocks when most investors have seemingly given up on them can be extremely rewarding. This appears to be the current opportunity in Magnachip and that is why I am buying shares. It's rare to be able to buy a tech stock at such a low valuation in terms of enterprise value which is just a fraction of the revenues. The cash-rich balance sheet is another huge positive as is what seems to be an opportunity to buy ahead of the next chip upcycle. At the current rock-bottom valuation, any good news could spark a big jump in the share price. This stock has trended up recently which seems to indicate some investors are starting to take note of this bargain buying opportunity. In the first half of January, I believe Magnachip shares could be poised to hit the 200-day moving average which is $8.63. However, in the next year or two, I think Magnachip shares will be back to trading above $20 per share.

The market is ignoring too many positives that Magnachip has going for it: A cash-rich balance sheet, big growth expected in the next upcycle thanks to AI and product releases, insiders buying and share buybacks, plus a separation of the company into entities that could lead to a deal that creates gains for shareholders.

No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

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