2023-11-28 01:41:54 ET
Summary
- Marvell Technology has experienced a 55% year-to-date rally and is still undervalued despite this increase.
- The company's financial performance has been solid, with revenue almost doubling in the last three fiscal years.
- Challenges in navigating oversupply and caution among enterprise purchasing managers have impacted revenue, but these issues are expected to be temporary.
Investment thesis
Marvell Technology ( MRVL ) is a hot stock in 2023, as it demonstrated a massive 55% year-to-date rally. My valuation analysis suggests that the stock is still significantly undervalued even after the rally. I think the discount is explained by the headwinds the company is facing in FY2024. However, my analysis suggests that challenges are easing and the company is returning to its stellar revenue growth path. Inventory is likely to be a headwind for a couple more quarters, but this is temporary. From the secular point of view, the company is well-positioned to capitalize on multiple technological super trends as Marvell is aiming to reach a very diverse set of promising end markets. All in all, I assign MRVL a "Buy" rating.
Company information
Marvell Technology is a fabless semiconductor supplier of high-performance standard and semi-custom products with core strengths in developing and scaling complex System-on-a-Chip architectures, integrating analog, mixed-signal, and digital signal processing functionality.
The company's fiscal year ends on the Saturday nearest to January 31. MRVL targets a diverse set of end markets, where Data center represented 41% of the total sales in FY 2023 .
Financials
MRVL's financial performance over the last decade could mislead readers because the 6.3% revenue CAGR looks too boring for a semiconductor company and profitability metrics were very unstable. But if we look closer, we can see that within the last three fiscal years, MRVL's revenue almost doubled, and the company demonstrated solid operating leverage.
MRVL's operating margins could have been much wider, but the company invests a substantial portion of its revenue in R&D. Over the last decade, the R&D to revenue ratio was 30% and above, which indicates the management's strong commitment to innovation. Wide free cash flow [FCF] margin ex-stock-based compensation [ex-SBC] allowed the company to build up a strong balance sheet with low financial leverage and strong liquidity. Having a solid financial position provides MRVL with more options to continue fueling business growth and innovation. Marvell pays dividends, but the above 0.5% yield looks not worth mentioning, as the payout ratio is below 15%. The capital allocation with more focus on reinvesting in business development looks sound to me as the management demonstrates the ability to deliver growth and profitability expansion.
Seeking Alpha
The latest quarterly earnings were released on August 24, when the company topped consensus estimates. Revenue declined YoY by around 12%, which was mainly due to the soft Data center sales, which decreased by 29%. The decrease was partially offset by a notable 32% growth in the automotive/industrial end market. Other end markets demonstrated flat YoY performance. Revenue weakness is weighted on profitability as the gross margin narrowed YoY from 51.8% to 38.9%. As a result, the operating margin went negative to -12.2%. However, it is crucial to underline that MRVL sustained a massive 35% R&D to revenue ratio even amid the notable revenue decrease. According to the latest earnings call , the management attributes revenue softness to challenges in navigating oversupply in multiple markets and caution among enterprise purchasing managers. That said, I expect the previous quarter's weakness to be temporary and not secular.
Seeking Alpha
The upcoming quarter's earnings are scheduled for release on November 30. Consensus estimates forecast quarterly revenue at $1.40 billion, which indicates a 9% YoY decline. The adjusted EPS is expected to follow the bottom line and narrow from $0.57 to $0.40.
Seeking Alpha
The expected continued softening financial performance in the upcoming quarter does not surprise me as the company's inventory levels are still substantial. As we can see, inventory levels more than doubled in fiscal 2023, and the improvement of the first two quarters of fiscal 2024 demonstrated subtle improvement. It is difficult to blame the management for such a massive spike in inventory levels, given that in fiscal 2023, MRVL's revenue was growing rapidly. Nevertheless, I expect the high inventory levels to weigh the company's financial performance over several quarters because the macro environment is still challenging.
As financial performance is expected to be soft due to macro headwinds, during the upcoming earnings call, the management might unveil some efficiency initiatives to relieve some pain for the bottom line. For example, last week, there were rumors that the company might close its Taiwan SSD unit with "hundreds of staff being dispersed and relocated to other companies." If this is the case, the management might upgrade its bottom-line guidance, which will highly likely be perceived optimistically by investors.
For the bottom line, it seems that the most challenging part of the downward is in the rearview window. According to Yahoo Finance , Data Center revenue is expected to demonstrate a 15.4% YoY decline, which is far better than last quarter's 29% YoY decline. According to the same source, Data Center quarterly revenue is expected by consensus at $530.7 million, a 15% sequential growth. This also looks much better than the Q2 sequential Data Center revenue growth of 5%. This is a clear indication that macro challenges are easing, and MRVL demonstrates a steady return to its growth trajectory.
From a secular perspective, I am optimistic about the company's future prospects. Substantial R&D investments suggest that Marvell strives to stand at the forefront of technological innovation to strategically position itself across diverse and promising end markets like data centers and automotive. As the demand for cloud computing and AI is expected to compound at double digits over several years, Marvell is well-positioned to capitalize on favorable secular trends, driving growth and market leadership. The automotive and industrial segments further highlight MRVL's versatility, focusing on advanced driver-assistance systems, autonomous vehicles, in-vehicle networking, and military and government solutions.
Valuation
MRVL rallied by 55% year-to-date, significantly outperforming the broader U.S. stock market in 2023. Seeking Alpha Quant assigns MRVL the lowest possible "F" valuation grade because multiples are substantially higher than the sector median. However, current valuation ratios align with the company's historical averages. That said, from the valuation ratios point of view, MRVL looks fairly valued.
I want to proceed with simulating the discounted cash flow [DCF] model. I use a 9% WACC for discounting, which is within the suggested valueinvesting.io range. Consensus revenue estimates forecast a 14% CAGR for the next decade, which I consider fair given secular solid tailwinds. I use an 18.4% TTM FCF ex-SBC margin for the base year and expect a 50 basis points yearly expansion.
According to my DCF calculations, the business's fair value is $55.5 billion. This is 15% higher than the current market cap, indicating an attractive upside potential. My target price for MRVL is $65.
Risks to consider
The fact that only five customers represented 55% of gross accounts receivable as of FY 2023 indicates a notable customer concentration. Furthermore, one customer accounted for 20% of net revenue during the last full fiscal year. Adverse changes in the financial conditions of MRVL's significant customers are likely to impact Marvell's financial performance and stability. That said, potential investors should be aware of the substantial concentration risks inherent to investing in MRVL.
A vast portion of net revenue is generated from shipments to China. Although the company states that much of its shipments to China relate to sales to non-China-based customers that have factories or contract manufacturing operations in China, I think substantial geopolitical risks are also relevant to Marvell. Tensions between the U.S. and China are still elevated, periodically leading to cutting-edge technology bans, especially in the semiconductor field. That said, MRVL's operations could be disrupted by adverse trends in geopolitics.
Last but not least, the company reports its Q3 earnings this week, and the stock might be a big mover in either direction. The stock might plunge after the earnings release even in case of a slight consensus estimate miss or immaterial guidance downgrade. As I consider MRVL to be a solid long-term bet, it would be better to use the dollar average approach and not opt in by allocating a substantial portion of the investor's portfolio at once.
Bottom line
To conclude, MRVL is a "Buy". The stock is very attractively valued at current levels, and the discount is attributable more to temporary headwinds. From the secular point of view, the stock is well-positioned to demonstrate strong revenue growth and profitability expansion over the long term. With a comprehensive reach across these diverse end markets, Marvell Technology is poised to thrive in the rapidly evolving technological landscape.
For further details see:
Marvell: High-Quality Business Attractively Valued