2023-09-26 05:41:32 ET
Summary
- Silicon Laboratories experienced shifting demand patterns in Q2, resulting in a decline in sales volume and prices.
- I anticipate a contraction in gross profit margin due to weakened demand and limited price growth.
- SLAB's revenue outlook for Q3 is dimmer, with a significant decrease expected compared to Q2.
Investment action
Based on my current outlook and analysis of Silicon Laboratories ( SLAB ), I recommend a hold rating. Due to excessive customer inventory and the recovery of the semiconductor shortage, SLAB experienced shifting demand patterns during the second quarter. 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. This aligns with the company's own expectations, as discussed during their earnings conference, where they mentioned foreseeing a gradual erosion of gross margins over time.
Basic Information
Silicon Laboratories Inc. stands at the forefront of secure and intelligent wireless technology, with the goal of advancing global connectivity. Their all-encompassing blend of hardware and software, user-friendly development tools, a top-tier network of partners, and robust customer support empower individuals to create innovative applications across various sectors, including industry, commerce, home, and lifestyle. SLAB streamlines the developer's journey in tackling complex wireless challenges at every stage of product development, enabling them to swiftly introduce groundbreaking solutions that transform industries, stimulate economic growth, and enhance quality of life.
Over the past four years, the company has maintained a CAGR of approximately 5%. Notably, the shortage of semiconductors in 2022 contributed to a significant 25% increase in revenue, which boosted this growth. However, it is essential to note that this level of growth may not be sustainable, as the supply shortage is gradually resolving .
Regarding the gross profit margin, it has remained relatively stable at around 59.8%. Nevertheless, I anticipate a compression in margins as the weak demand and price growth outlook are expected to force the company to reduce its operating leverage. In their earnings conference , company leadership talked about their initiatives to control operational costs, which included actions like imposing a freeze on hiring and reducing executive compensation. Considering the challenging economic conditions, I anticipate that the company will persist in its cautious approach to managing expenses.
Review
In the second quarter, the company reported revenue of $244.9 million, reflecting a 6.9% decrease y/y. Within this, Industrial & Commercial revenues amounted to $165.3 million, marking a substantial 14.7% y/y increase. Conversely, Home & Life revenues were $79.6 million, showing a significant decline of 33.1% y/y. The gross margin remained at 58.8%, and the non-GAAP EPS stood at $1.04. There was approximately a 9% increase in inventory from the previous quarter.
Currently, SLAB is facing notable shifts in demand dynamics. This is primarily attributed to an excessive inventory burden, eroding customer confidence. Consequently, SLAB has provided lower guidance for the third quarter, anticipating revenues in the range of $190 million to $210 million. The main driver behind this lower forecast is a demand issue stemming from high customer inventory levels, resulting in reduced unit sales. As the semiconductor shortage gradually subsides, customers have begun to reduce their semiconductor inventory holdings. This reduction in inventory has resulted in decreased demand, as customers are no longer concerned about the shortage disrupting their sales.
Due to this declining demand, it is expected that there will be limited pricing growth in FY23. Since November 2022, the Semiconductor Producer Price Index [PPI] has decreased from approximately 57.59 to around 56.66 in June 2023, representing a 1.61% drop. The primary challenge faced by the company is the decrease in demand for its products, which directly impacts the number of units sold as well as the price of each unit. This reduced demand is not unique to SLAB but is an industry-wide issue, with other players also reporting a similar drop in demand.
Looking ahead to the third quarter, it is anticipated that revenue will decrease due to weakened demand and declining prices. This aligns with the management's guidance range of $190 million to $210 million. This projected decline represents a significant 22% decrease compared to the second-quarter revenue of $244.9 million, especially when considering the lower end of the guidance range.
Due to reduced demand and sluggish price growth, SLAB achieved a non-GAAP gross margin of 58.9%. I expect margins to contract further due to the company needing to reduce its operating leverage in response to the subdued demand and price growth outlook. In their earnings conference, company leaders addressed ways to control operational expenses, including implementing measures like a hiring freeze and reducing executive compensation. This anticipation of a margin reduction is consistent with the company's own forecasts.
"But the top little comment here is this is very much in line with our expectations and long-time commentary that over time, we should expect to see some modest erosion of gross margins, and that's a message that we haven't talked about." 2Q23 call
Valuation
I believe SLAB will grow at 5% in FY24 as there is a significant shift in demand due to issues stemming from high customer inventory levels, which results in lower unit sales. Due to the high customer inventory levels, weakened demand has driven prices lower. This issue is expected to carry forward into the 2H as management also guided a lower third quarter revenue of 190 million to 210 million, which is a 22% decrease compared to the second-quarter revenue of $244.9 million when considering the lower end of the guidance range.
SLAB is currently trading at ~21x forward EV/EBITDA. Its peers are trading at a median of 15.32x. Given that SLAB's 18% EBITDA margin is lower than peers median of 31.71% and lower NTM growth rate of -7% vs. peer's median of 8%, I expect its multiple to contract towards peers' median of 15.3x. My price target is ~$91, which represents a downside of 21%. I recommend a hold rating as I believe that SLAB is overvalued when compared with peers given that it has lower margins and growth outlook. In addition, it is facing headwinds on demand and pricing growth which is expected to drive upcoming revenue lower.
Risk and final thoughts
Risks encompass competition from larger and more well-endowed companies compared to SLAB, the necessity of sustaining foundry partnerships to guarantee sufficient supply, the typical cyclical nature of the semiconductor industry, potential challenges in integrating acquisitions, and the potential adverse effects of increasing interest rates on the company's valuation metrics and borrowing expenses.
SLAB is grappling with shifting demand dynamics due to excessive inventory levels, which have eroded customer confidence. This situation led to lower guidance for the third quarter, with revenue expected to be in the range of $190 million to $210 million, representing a significant 22% decrease from the second quarter. The decline in demand and limited pricing growth for FY23 have impacted SLAB's gross margin. I anticipate margins to compress due to the lower price as weakened demand and limited price growth necessitate a reduction in operating leverage. This is also in line with management's guidance. From a valuation perspective, SLAB appears overvalued compared to its peers, as it is trading at a higher multiple despite having lower margins and a growth outlook. Given the headwinds of demand, pricing, and weaker revenue guidance for the third quarter, I recommended a hold rating.
For further details see:
Silicon Laboratories: Weak Guidance Driven By Recovery In Semiconductor Supply Shortage