2023-11-09 07:55:01 ET
Summary
- SLAB reported disappointing third-quarter results with declining revenue and deteriorating margins.
- SLAB's fourth-quarter outlook is extremely negative, with projected negative EPS and further declines in revenue and margins.
- The semiconductor glut, challenging macroeconomic backdrop, and weak demand environment are major factors contributing to SLAB's poor performance.
Investment action
I recommended a hold rating for Silicon Laboratories (SLAB) when I wrote about it the last time, as I believe that excessive customer inventory and the recovery of the semiconductor shortage resulted in SLAB experiencing shifting demand patterns. This led to a decline in both sales volume and prices, resulting in disappointing second-quarter performance and a dimmer revenue outlook for the third quarter. Additionally, I anticipate SLAB's gross profit margin to further contract as weakened demand and limited price growth necessitate a reduction in operating leverage.
In this post, I am rerating my previous hold rating to a sell rating. For the third quarter of 2023, SLAB reported disappointing results as revenue across the board declined. In terms of margin, it is deteriorating and getting worse when compared to the previous second quarter. For the upcoming fourth quarter, revenue and margins are anticipated to decline even further. The most shocking news was management's guiding EPS to a loss. All these were mainly driven by the semiconductor glut as well as the extremely challenging macroeconomic backdrop.
Review
SLAB reported weak third-quarter 2023 results as revenue across all segments as well as on a consolidated level all declined in the double-digit range. Revenue for the third quarter was $204 million, a 24% decrease from the previous year. The average selling price in the quarter declined sequentially, primarily due to product and customer mix. Sequentially, there was a decrease in unit volume as well. During the quarter, both business units' revenue decreased from the previous year. At $121 million, the Industrial & Commercial [I&C] segment saw a 17% decrease from the same time the previous year. I&C saw declines in all three of its product groups during the quarter, with the broad industrial category seeing the biggest drop. The $83 million in revenue from Home & Life was down 33% year over year.
In terms of margins, SLAB's margin contracted substantially. For the third quarter of 2023, non-GAAP operating income was 12% and non-GAAP EPS was $0.62. When compared to the second quarter , this is a big step down. In the previous quarter, non-GAAP operating income was 16%, which represents a 25% contraction in operating income margin. The previous quarter's non-GAAP EPS was $1.04. When compared to the third quarter's EPS, it represents a staggering 40% decrease.
On the back of declining revenue across all segments as well as contracting margins, SLAB guided to an extremely negative fourth-quarter outlook. SLAB projects a non-GAAP gross margin of roughly 53% for the fourth quarter. For context, the third quarter gross margin was 58.5%, which means SLAB is expecting a 5.5% contraction in margin. The impact of fixed cost developments in its cost of goods sold, which are being absorbed over a significantly lower revenue level, is the main reason for the lower gross margin for this quarter. Most notably, SLAB anticipates that EPS will be negative for the fourth quarter. For the fourth quarter, non-GAAP loss per share is projected to be between $1.22 and $1.66. This is a cause for concern for investors, as over the past few quarters, they have reported positive EPS.
In the third quarter, SLAB was operating in a difficult market landscape. This was mainly driven by the 2020 to 2023 global chip shortage , which caused end clients to frantically buy semiconductor products. As semiconductor sales eased and the frenzy of buying stopped, it resulted in low demand and high inventory. This continues to be a challenging combination that characterizes the current market environment as well as the future. Moving forward, I anticipate the demand environment for SLAB end customers will continue to be weak due to the current semiconductor glut . On top of the low demand and high inventory levels plaguing the market, high inflation and interest rates are not helping out either. These factors are suppressing retail expenditures, which only add pressure to the already battered semiconductor market. In order to better manage its operating expenses, SLAB has decided to immediately implement structural headcount and other spending reductions, taking into account the length and severity of the current downturn. From there, I can see that SLAB is desperate to regain profitability, as both its revenue and margins are all declining and EPS for the upcoming quarter is going into a negative zone.
Valuation
I believe SLAB will face declining growth for the next two fiscal years. This is in line with management guidance, as they guided a revenue range of $70 million to $100 million for the fourth quarter, and revenue for the fourth quarter is expected to decline. In addition, SLAB expects both business units' revenue to decrease for the next quarter. Overall, SLAB's revenue outlook is very bleak and pessimistic. Moving onto margins, SLAB suffered significant margin contractions in the third quarter. Moving into the fourth quarter, these margins are expected to contract even further. The most crucial point in the earnings call is that SLAB expects that its fourth-quarter EPS will be negative. With these in mind, I expect SLAB's margin to contract to well below the 2021 level.
SLAB is currently trading at ~28x forward EV/EBITDA. Its peers are trading at a median of 14.5x. Given that SLAB's 6.3% net margin is significantly lower than its peers median of 21% and a lower 1-year expected growth rate of negative 22% vs. peers' median of 9%, I expect it's multiple to contract towards peers' median. In fact, I believe SLAB should be trading below its peers' medians because of its weaker financial indicators. By applying a 20% discount to 14.5x, my price target is ~$60, which represents a downside of 36%. Given the extremely weak and pessimistic results reported by SLAB as well as their all-around weaker performance against peers, I am rerating my previous hold rating to a sell rating in this post.
Risk and final thoughts
One upside risk to my sell rating is the unexpected improvement in the currently weak semiconductor market landscape. If the ongoing semiconductor glut were to ease, it would lead to increased demand for semiconductor products. In turn, it will lead to higher revenue and a better growth outlook. The improvement in the semiconductor market landscape will also allow SLAB to moderate its margin contraction issues.
In conclusion, SLAB's outlook is bleak, and it is on a downward path. Its third-quarter results were dismal, as revenue declined and margins were poor. These poor results were a result of the semiconductor glut, which has also been exacerbated by high inflation and interest rates. Moving into the fourth quarter, both revenue and margin are expected to continue to decline, and EPS is expected to be in the negative. When compared to peers, SLAB's performance is subpar, and given its double-digit loss potential, I am rerating SLAB as a sell.
For further details see:
Silicon Laboratories: Rating Downgrade As Semiconductor Glut Is Negative For SLAB