SLAB - Silicon Labs Impresses With Better Results And Guidance Despite Weakness In Consumer IoT

Summary

• Despite weakness in consumer smart home demand, Silicon Labs managed a beat-and-raise quarter with sequential declines limited to the mid single digits.
• Silicon Labs will need to turn strong design wins in 2022 into revenue and new use-cases in 2023, as pricing won't provide the same tailwinds and end-markets are still shaky.
• Investors have started moving back into semiconductor stocks, reinflating Silicon Labs' multiple; there should be enough growth here to satisfy growth-stock investors, but waiting for a pullback is an option.

The Street thinks it has the semiconductor downturn pretty well dialed in now, and with that the stocks are coming back - the SOX index is up about 25% over the last three months, handily outpacing the S&P 500 and NASDAQ. Within that, differentiated growth stories have also been quite strong, with both Silicon Labs ( SLAB ) and Lattice ( LSCC ) on a tear over that time, and with Silicon Labs posting a rare beat-and-raise quarter with its fourth quarter results, it's been all the better for sentiment.

Sell-side analysts haven't done a full U-turn yet, but the average Street price target fell from $203 to $148 between my March 2022 and December 2022 updates, and now it's back up to about $187 with analysts reapplying gaudy P/E multiples to 2023 or 2024 earnings to drive more robust targets. For my part, Silicon Labs has surpassed the point where valuation really factors into the discussion, and that's the nature of growth semiconductor stocks (and growth tech in general) - you only get a handful of opportunities to buy in at attractive-looking multiples, and it's usually a scary time to do so.

I definitely like the long-term story here and won't try to talk anybody out of their holdings, but with an elevated amount of turbulence still out there in the end-markets, I'd be more inclined to wait for some pullback if I didn't own the shares, and the track record here is that there's usually at least one 10%+ pullback every year or so.

Stronger Than Expected Results, With Healthy Metering Demand

Silicon Labs had a rare beat-and-raise quarter, with the latter part being the more unusual component this quarter for other semiconductor companies. While smart home demand is quite weak, a situation echoed by others in the space, connected equipment and metering demand remain healthier.

Revenue rose 23% year over year and declined about 5% sequentially, beating expectations by around 3%. The Industrial & Commercial segment saw 36% yoy and 8% qoq growth, while Home & Life rose 8% yoy and declined 19% qoq on that weaker smart home demand.

Gross margin was slightly weaker, falling 10bp yoy and 20bp qoq to 61.3%, but beating expectations by about a point. Operating income rose 43% yoy and fell 21% sequentially, with operating margin up 260bp yoy and down 120bp qoq to 18.9%, beating by two points.

Inventory rose 14 days sequentially, which was pretty high relative to other chip companies, but the overall level of 90 days inventory isn't bad. Management also stated that distributor inventory levels were stable at 59 days and that orders were showing more stability, with lead-times around 26 weeks (below the typical 30 weeks).

Management guided for a 4% sequential decline in revenue in the March quarter, or about 2% to 3% higher than the Street had expected. Gross margins were also guided strongly, with roughly four points of upside to the prior Street estimate.

Industrial Demand Has Held Up, With New Use-Cases Helping

Most of Silicon Lab's revenue growth in FY'22 was driven by pricing, and that's not unusual in what was a capacity-constrained market that allowed for robust pricing power. That pricing strength isn't going to repeat in 2023 and the company will need to see better unit volumes to avoid the year-over-year revenue declines that many other semiconductor companies will see.

Fortunately, IoT remains a comparatively healthy segment of the market. Nordic Semiconductor ( OTCPK:NDCVF ) saw a similar 5% sequential erosion in its revenue, despite greater exposure to the weaker cellular IoT market, and while it's difficult to tease out IoT performance form STMicroelectronics ' ( STM ) earnings, it sounds as though that business held up reasonably well. NXP Semiconductors ( NXPI ) seemed to have a weaker performance, but management didn't really tease out the IoT numbers other than to confirm meaningfully more weakness in consumer IoT (where it's comparatively stronger) than industrial IoT.

This year should be relatively healthy for industrial IoT despite a slowing macro environment and the risk of inventory corrections. IoT devices are increasingly being incorporated into edge applications like monitoring and asset tracking, and I expect that trend to continue from here. Silicon Labs mentioned a 52% increase in design wins in 2022 and put a bit of a spotlight on its new SiWx917 Wi-Fi SoC. This chip includes a Wi-Fi 6 combo chip and ultra-low power capabilities that should open new use-case and end-market opportunities for Silicon Labs in 2023 and beyond (industrial asset tracking, wearables, and motor control are possibilities, but that's largely guesswork on my part).

The Outlook

Not much changes in my outlook for Silicon Labs, as I still see a possibly delicate balance between price pressure and volume growth in FY'23, but a wide range of long-term opportunities across consumer, industrial, and municipal markets. While guidance for Q1 was good, I still expect margins to revert toward their longer-term mean, which means a decline from the 20% margin seen in FY'22 likely down to the mid-teens for FY'23 before a gradual rebound back up into the high-teens.

I do still see an outside risk of a year-over-year revenue decline in FY'23, but I expect multiple years of double-digit growth to resume in FY'24, driving five-year annualized growth around 13% and longer-term growth around 11%. Given the large and growing addressable market for IoT, particularly in municipal and industrial use-cases, I do see upside to my numbers.

Although Silicon Labs has probably seen a peak in margins for a couple of years, I do expect long-term improvement and I believe long-term adjusted free cash flow margins in the low 20%'s are possible (from the mid-single-digits today). That supports robust free cash flow growth over the next decade which can fuel buybacks, dividends, and M&A.

As I said in the open, valuation really isn't a compelling discussion with Silicon Labs anymore. We could debate the merits of a 35x forward earnings multiple or a 40x multiple, but at some point that becomes a choose-your-own-outcome exercise. This is the sort of stock where you either have to wait patiently for pullbacks or just buy and trust in the growth momentum (and that the market will continue to reward that growth with higher multiples).

Even so, discounted cash flow suggests a high single-digit potential annualized return from here while a 20%-plus operating margin in 2026 supports a fair value in the $180's if I apply the resulting margin-driven multiple to '26 revenue and discount back.

The Bottom Line

While it's not my normal investment style, I do occasionally go with "just buy the growth and wait for it to work out" stories. If I were to do that in the chip sector I'd rather do it with Lattice, but that's down to personal preference. I can't really recommend Silicon Labs for readers other than more aggressive growth investors, and for them I think Silicon Labs' leverage to the large potential of IoT should be compelling, but for others I can say that there will be another pullback at some point and it's worth doing due diligence now to be prepared for when that happens.

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