SMTC - Semtech: Buy Post-Correction Recovery

2023-12-20 19:30:50 ET

Summary

• We maintain our buy-rating on Semtech Corp.
• 3Q24 results and outlook confirm our belief that SMTC is now better positioned to outperform after IC customers' inventory correction is complete. We see top-line growth accelerating through 2024.
• We see more room for outperformance towards 2H23 as the Signal Integrity and Protection inventory correction is now behind us.
• While we understand we were early with our buy-rating, we now believe the stock has bottomed. We recommend investors initiate a position in SMTC stock on pullbacks.

We continue to be buy-rated on Semtech Corporation ( SMTC ). 3Q24 results and outlook confirm our belief that SMTC is now better positioned to outperform after IC customers' inventory correction is complete. We see top-line growth accelerating through 2024. We initiated the stock with a buy-rating in mid-October based on our belief that SMTC is pricing in near-term weakness to its stock price and outlook; the stock is underperformed the S&P 500 by 14% since. Our bullish sentiment might've been early, but we don't believe it is wrong. SMTC stock is down 8% over the past three months, versus the S&P 500 up 7% during the same period. The stock is underperforming the S&P 500 by 48% and 9% YTD and over the past six months, respectively. We see attractive entry points on the pullback for investors to buy the bottom as we see a turnaround moment ahead.

The following graph outlines SMTC's performance over the past three months against the S&P 500.

This quarter , SMTC reported revenue of $200.9M, up 13.1% Y/Y but down 16% QoQ, in-line with consensus estimates of $200M. We're not too surprised about slower sales growth this quarter, as we think the IoT customer inventory correction is now wrapping up. Management is guiding revenue to decline 0-10% QoQ next quarter to $180-200M, trailing a consensus of $205.7M; guidance for next quarter leads us to believe that the weakness is priced into both the stock and outlook now. Consistent with our expectations last note, Signal Integrity Group and Protection and Sensing sales bottomed, growing at a slower QoQ pace this quarter compared to 2Q24, up 5% QoQ to $48.7M and 4% QoQ to $50.6M, respectively - the two segments represent ~40% of total sales. Management now expects the latter to decline QoQ due to consumer seasonality, and sees Signal Integrity and IoT sales to be flat to down QoQ as the correction wraps up. In spite of the end demand weakness, SMTC gross margins are holding well, with no Non-GAAP gross margin expanding to 51.3% this quarter due to a healthy IC sales product mix. We see attractive entry points to jump into the stock at the bottom ahead of the 2024 sales recovery. We expect top-line growth to rebound once the inventory correction completes.

The following outlines SMTC net sales by segment this quarter.

Still, we don't think SMTC is without risks. We think the company's IoT business may be exposed to the longer recovery path post-correction. Macro weakness can weigh on the pace of end market recovery; while we now think customer inventory correction is over, we're monitoring for demand rebound. SMTC is for the patient as we believe the company will be able to reaccelerate top-line growth in 2H24 materially. The company's financial health is also on the radar for analysts and investors alike; looking at leverage, liquidity, and funds, SMTC harbors a noteworthy rise in its debt-to-total assets ratio over the past three years; provided data highlights the following: 2021: 0.16; 2022: 0.14; 2023: 0.65, expressed as percentages. We see a higher financial risk for the stock in that regard. Still, we see the stock re-rating higher as product mix health improves next year and believe management is equipped to manage near-term financial obligations.

Valuation

SMTC is cheap, in our opinion, particularly in comparison to Ambarella ( AMBA ). The stock is trading at 3x EV/C2023 Sales versus the peer group average of 6.5x and AMBA at 10.9x. We think SMTC should be valued on an EV/Sales metric. We believe SMTC is a value stock at current levels based on its historical multiple and growth potential in 2024, especially considering the higher multiples in the semi space post-AI boom earlier this year. Looking forward, we see attractive entry points to jump into the stock at current levels as it trades below the semi peer group, and we see the stock outperforming its peer group in 2024. We think the worst is in the rearview mirror and recommend investors explore entry points at current levels.

The following chart outlines SMTC's valuation against the peer group.

Word on Wall Street

Wall Street shares our bullish sentiment on the stock. Of the 14 analysts covering the stock, 12 are buy-rated, while the remaining are hold-rated. The stock is currently trading at $22 per share, down from 52-week highs of $35.18 and lows of $13.13. The median and mean sell-side price-target are $30 for a potential 37-39%.

The following charts outline sell-side ratings and price-targets for SMTC.

What to do with the stock

We continue to be bullish on SMTC. We think the stock is now better positioned to outperform in FY25 as IoT inventory correction will be completed. Management guidance and stock price behavior for the past six months lead us to believe the weakness has been priced into the stock for the most part. We think SMTC is better positioned to outperform in 1H24.

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