Summary
- MACOM's December quarter results were basically in line, but management warned of weaker orders and guided to a sequential decline for March.
- Significant exposure to defense will cushion some of the cyclical downturn, as will ongoing investments in high-end datacenter connectivity/interconnect, but telecom and broadband look softer now.
- High-performance compound semiconductors generally support higher barriers to entry, and MACOM's margins stand out for a company of its relatively small size.
- Value and growth in chip stocks don't often intersect, but MACOM's valuation looks pretty reasonable relative to the growth I expect on the other side of this cyclical lull.
In the semiconductor sector these days, "not bad" is the new "good", and MACOM ( MTSI ) reported largely inline December quarter results and guidance that, while calling for a sequential decline, still suggests that the business is holding up better than for most. That makes sense to me, given MACOM's leverage to attractive markets like defense and high-end datacenter, though 5G, broadband access, and cable infrastructure are likely to be soft a while longer. Moreover, trough operating margins (non-GAAP) seem likely to stay in the 30%'s, a level that would be aspirational for many other companies.
The challenge for MACOM is growing into the valuation. I like the company's leverage to defense, datacenter, broadband, and some growth segments of industrial, as well as the lack of exposure to weak consumer markets, but robust expectations are already built into the valuation. Still, for investors more interested in growth and less concerned about valuation, this is a name worth watching.
A Better Than Average Quarter In More Challenging Times
MACOM's quarter will definitely stand out from other semiconductor reports, as the company continues to leverage the benefits of producing high-spec products for markets with meaningful barriers to entry. That said, guidance is still calling for a meaningful slowdown, so MACOM can only outrun the macro environment just so far.
Revenue rose 13% year over year and about 1% quarter over quarter, meeting expectations (and management guidance) for the quarter. The Industrial & Defense business saw about 6% year-over-year growth and 2% sequential contraction, while Datacenter was up more than 35% yoy and 10% qoq and Telecom was up 10% yoy and down 1% qoq.
Gross margin rose about 120bp yoy and flat sequentially at 62.6%, a high gross margin for a semiconductor company with less than $750M in annual revenue, and about 10bp above Street expectations. Operating income rose 20% yoy and about 3% qoq, with margin up two points yoy and 70bp qoq to 32.7%, beating by about 30bp.
Inventory days declined in the quarter (down about 15 days to 136), but are still elevated on a longer-term basis.
Management did guide lower for the next quarter, as weakness in carrier spending on 5G, cable spending on broadband, and datacenter hits the business. MACOM is now looking for a nearly 7% qoq decline in revenue at the guidance midpoint, about 6% below the prior Street expectation. Even with that revenue drop, though, margins appear to be holding up well, as management guided to 62.5% gross margin (10bp below Street and down just 10bp sequentially).
A Pause In The Growth Story
I don't see anything fundamentally wrong with MACOM, nor anything to really worry about beyond a few quarters of more challenging demand. Weaker 5G spending was already expected in 2023, and has since been confirmed by equipment vendors like Ericsson ( ERIC ), as developed market carriers slow spending and enterprise 5G has yet to really ramp.
The slowdown in broadband has come on a little more quickly, hitting others like MaxLinear ( MXL ), as cable service providers are now dealing with declining net subscriber adds after a big surge during the pandemic. While content growth and upgrades can offer some upside, including share gains in 10G PON (driven by "fiber to the X" or FTTX), this market is likely to be softer for a few more quarters at least.
I'm less concerned about the datacenter market. "Digestion" of past capacity expansion among hyperscalers will slow the business, but there are still significant ongoing investments in high-end connectivity (400G and above), as well as in PAM-4 for datacenter interconnect. With a robust line-up of crosspoint switches, PAM4 DSPs, TIAs, lasers, and chips for active copper cabling, I see MACOM as well-positioned to benefit from ongoing spending on upgraded high-end datacenter capabilities.
I'm also not worried about the defense side of the business (around a quarter to 30% of sales). Defense spending should pick up moderately in 2023, and I like MACOM's leverage to advanced communications (including satellite), radar, smart weapons, and electronic warfare. I'd also note that military sales tend to be sticky, high-margin business; defense contractors have less flexibility to swap in alternate components just to save money and these sockets don't tend to see the annual price erosion that's commonplace in the analog space.
The industrial space is a tougher call. I'm not exactly bullish on most industrial markets in 2023, but certain markets like healthcare and aerospace should be strong, even if others like test & measurement start to fade, and I like the company's long-term leverage to wireless opportunities (the company recently logged wins for automatic toll detection and wireless communications for an auto customer).
The Outlook
I expect that MACOM will see two consecutive quarters of sequential sales erosion and that it will take about a year to get back to this quarter's revenue level (so, no real year-over-year growth until the March quarter of 2024). I expect that Industrial and Defense will hold up better (supported by defense spending), and I won't be too surprised if there's some "choppiness" in Datacenter given differences in spending plans between the hyperscalers (who are still investing in high-end connectivity/interconnect) and more conventional datacenter players.
I do expect a few years of double-digit growth after this corrective cycle, and I expect high single-digit longer-term revenue growth from MACOM. As there's still plenty of room for technologies like gallium nitride (or GaN) and GaN-on-SiC to expand from here, there could be upside as new product opportunities emerge and as new verticals fold into the served addressable markets.
I'm not expecting much margin deleverage here, partly due to the nature of many of the company's offerings and higher barriers to entry relative to other types of semiconductors. I think operating margin will just "hang out" a bit in the 33% range before resuming a multiyear climb toward the high-30%'s. I expect this all to translate into low-to-mid-20%'s adjusted FCF margins over time, and I can see upside into the high-20%'s if the company exceeds my operating and fixed asset leverage assumptions.
I also wouldn't be surprised to see more M&A, although on a selective basis. MACOM announced the acquisition of a small European chip company (OMMIC SAS) that shares MACOM's deep base in compound semiconductors (GaAs/GaN MMICs), while also expanding MACOM's production capacity (with 6" wafers) and footprint - as more companies look to source away from China, it may well serve MACOM well to have additional manufacturing capacity in Europe.
All of this works out to long-term growth estimates in the high single-digits for revenue and the low double-digits for FCF. The shares don't look that cheap on discounted cash flow, but for growth chip companies that's more the norm than the exception. Using growth-based multiples on revenue and EBITDA (6.5x and 20x, respectively), I can get a fair value around $70.
The Bottom Line
Growth doesn't frequently come cheap among semiconductors, and particularly those that seem well-placed to weather brief downturns. That there's any apparent undervaluation is arguably a strong point, and I think growth-focused investors willing to consider semiconductor names may want to check these shares out - they haven't exactly underperformed over the last year but there could be upside as the market starts to look past this bottom in the chip cycle.
For further details see:
Differentiated End-Markets And Strong Execution Likely To Spare MACOM Through The Downturn