Microchip Downgraded to Neutral

We recently downgraded our recommendation to Neutral from Outperform on Microchip Technology Incorporated (MCHP).

Microchip Technology recently narrowed its guidance for the third quarter of fiscal 2011 based on bookings and sales activities in October and November. The company now expects net sales to be down 3% – 7% sequentially, compared with the previous estimate of a decline of 2% – 8%.

Microchip stated that the two months of the December quarter progressed as expected. Gross margin is still projected around 59.1% – 59.3%. Earnings per share are projected between 55 and 59 cents.

Microchip is well positioned in its core microcontroller market, which continues to propel growth for the company. Microchip continues to be a leading player in the 8-bit and 16-bit microcontroller space.

Design activities for 8-bit flash microcontrollers continue to be strong. Secondly, the company is targeting the high-performance 16-bit microcontroller market, and demand is reflecting strong momentum. Thirdly, the 32-bit microcontroller product line continues to make good progress.

In April 2010, Microchip acquired Silicon Storage Technology for $295.4 million. Silicon Storage is a global leader in embedded flash technology along with licensing of these technologies. Microchip identified the core and non-core assets of SST.

After operating the super flash memory business and RF business (held for sale) for two quarters, Microchip found synergy between SST’s RF business and Microchip’s wireless controller and analog business. Hence, Microchip decided to keep the super flash memory and RF businesses of SST as ongoing businesses of Microchip.

Microchip substantially eliminated the excess overhead and reduced the operating expenses of the SST business. The super flash memory and RF divisions of SST added approximately $40 million of revenue in the September 2010 quarter.

The restructuring and integration of SST is now complete. Microchip expects significant operational synergies from its memory business and technology synergies with Microchip’s micro controller business. The acquisition not only makes use of Microchip’s strong cash balance, it also strengthens the company’s product portfolio.

Earnings estimates for fiscal 2011 have been static in the last thirty days. Although we believe Microchip is well positioned in its core microcontroller market, which continues to propel growth for the company, we are a bit concerned about the ongoing inventory correction in the semiconductor industry and its ripple effects on chip companies.

Hence, we have downgraded our recommendation to NEUTRAL. Our Neutral recommendation is supported by a Zacks #3 Rank, which translates to a short-term rating of Hold.

MICROCHIP TECH (MCHP): Free Stock Analysis Report

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