2023-07-22 09:18:59 ET
Summary
- Silicon Laboratories Inc (SLAB) is highly focused on the wireless connectivity industry, with a strong track record of outperforming markets, but its high stock price could mute potential returns.
- SLAB's future opportunities lie in the IoT market, which is expected to reach $17.4 billion by 2025, and the company has a diversified customer base with its largest customer supplying only 5% of revenues.
- Despite the opportunities, the semiconductor industry presents several risks including a complex supply chain and high levels of long-term debt, making investment in semiconductor companies potentially risky.
Investment Rundown
It seems that Silicon Laboratories Inc ( SLAB ) has been caught up in the hype around semiconductors this year, and the last 12 months. The stock trades at a rich p/e of 37x FWD earnings. Despite growth looking good, paying this high of a premium will mute potential returns in the coming years as a reality violation will eventually need to be reached.
SLAB is highly focused on the wireless connectivity industry, one that is estimated to see strong growth going forward. The growth is driven by the increased adoption of machine-to-machine interactions, and a 12.8% CAGR until 2027 seems reasonable. SLAB has a strong track record of outperforming the markets, and that makes me prone to at least have a hold rating for the company at this time.
Company Segments
The semiconductor industry has seen massive growth in the last few years, but in the short term might face some challenges as inventories have been built up. However, the long-term demand for semiconductors is highly likely to continue, seeing as the products are in basically all of our technologies.
The revenue streams for SLAB can be divided into two distinct parts, Industrial & Commercial, and Home & Life. The largest of the two is Industrial & Commercial, which in Q1 of 2023 netted $151 million in revenues. SLAB has an international presence and makes various analog-intensive mixed-signal solutions. Some of the largest markets the company serves are the United States and the Asia Pacific.
Revenue Mix (Earnings Presentation)
SLAB has been very good at diversifying its customer base. The largest customer supplies 5% of the revenues, which I don’t find risky or too high. There is a large portion of long-tail customers with the company. This creates a longstanding foundation of revenues to stand upon.
IoT Market (Earnings Presentation)
Where a lot of the future opportunities lie for SLAB though exist seems to be in the IoT market. The market growth until just 2025 is that it will reach $17.4 billion in valuation. This would be an annual growth rate of 19% between 2016 and 2025.
Earnings Highlights
It seems a lot of companies are reporting their earnings soon, at least when looking at semiconductor-related companies. For SLAB, the expectations are that on July 26 , 2023, the company will post a slight QoQ decline for the EPS. Estimates predict it landing at $1.03 per share, a 9% QoQ decline. This seems to come off the back of a softer and consistently difficult market environment to navigate in. I think this seems like a likely result, but I don't want to rule out the possibility that they see EPS miss estimates. The rise of interest and still quite expensive material costs could dig into the bottom line harshly. This uncertainty is part of why I think they are more of a hold than a buy right now. I also think that margins will go lower, which will further increase the loss of net incomes on a QoQ basis.
Q1 Highlights (Q1 Earnings Report)
For Q1 of FY2023, SLAB posted some decent results. Revenues landed at $247 million in total, a 6% YoY growth. Gross margins reached 62.3% which is 1.78% above its historical average. The coming quarters will likely see margins below this as the R&D expenses remain quite high for the entire industry. With more and more competitors entering every year, the need to stay ahead of the curve becomes crucial. In Q1, the R&D expense was 36% of the total revenues. This takes a toll on the bottom line as so much capital is needed to be invested here.
Capital Deployment (Earnings Presentation)
But that hasn't stopped the company from buying back shares worth of $2 billion since just 2021. FCF has been strong leading up to the last 12 months. Now they are negative by $47 million. When the hype surrounding semiconductor companies in 2022 reached its peak, SLAB was able to generate $183 million in FCF, which helped fuel these buybacks. But it seems that a lot of the buybacks are also funded by cash at hand. In 2022 the cash reached over $1 billion but has since decreased to $716 million. Inventory levels have also increased, and sit above $100 million currency, but it hasn't translated to a stronger ROA . Rather, it's far below the 5-year average of 16.4%, reaching just 3.8% in the last 12 months.
Risks
The semiconductor industry, while full of opportunities, also presents several inherent risks for companies operating within its dynamic landscape. One of the foremost challenges lies in the complex supply chain. Companies rely on raw materials and components from various regions worldwide, making them susceptible to disruptions caused by natural disasters, geopolitical tensions, or logistical issues. Such disruptions can lead to production delays, and shortages, and hinder companies' ability to meet customer demands promptly.
Growth Targets (Earnings Presentation)
Besides this, SLAB has also reached its highest level of long-term debt ever right now, sitting at $529 million. Back in 2022, they managed to pay it all down, going from $428 million to 0. But as these loans are likely higher interest rates, I expect to see more interest expense in the coming years. If SLAB can quickly grow its top line and preserve margins, it might not be an issue in the end.
As with all companies, though, when there are some predictions of a report showing a decrease in QoQ growth, a surprise will cause the share price to jump significantly. You aren't missing out on that though with a hold rating, but buying for the hopes of it doesn't seem like a good risk/reward equation right now.
Industry Comparison
It seems difficult to find any decent deal related to semiconductors right now. Many of the smaller high-growth opportunities have had their share prices run up quickly. Looking at Power Integrations Inc ( POWI ) for example, one which has grown nearly 30% in the last 2 months now sits at a p/e of 47 . The company makes analog and mixed-signal integrated circuits. A market that will likely grow just as quickly as the ones SLAB is in. However, none of the companies look that compelling on a valuation basis. The margins for both of them are great, but POWI is pulling ahead though. Net margins of 22% and FCF margins of 13% make it to me more appealing, even with a higher p/e multiple. I think that investors should be careful though when investing in semiconductors and having a smaller portion of the portfolio diverted for it seems to best practice for proper risk management.
Final Words
Investing in semiconductor-related companies right now seems quite risky, as many of the company's share prices have reached unreasonable valuations. For SLAB that is the case and I don’t see them as a reliable investment right now. The downside risk seems larger than the upside potential in the medium term. Given the solid market outlook, though, it makes more sense to rate it a hold than anything else.
For further details see:
Silicon Laboratories: Price Is Too High For A Decent Investment Case