Microchip Technology: A Tech Gem

While not a marquee name, the microcontroller maker boasts steady profit growth and a nice dividend yield

by Clyde Montevirgen From Standard & Poor's Equity Research

Unlike many other semiconductor companies, Microchip Technology (MCHP; recent price, $34.63) has not only been profitable every year over the last decade, but it has increased its earnings per share for most of those years. The company established a profitable business model in an 8-bit microcontroller market that companies had avoided due, we think, to fears of product commoditization—and it has emerged as the market leader in this segment.

We believe that the stock, at current levels, does not fully reflect our view that Microchip Technology will aggressively take share in the 16-bit microcontroller market, in addition to further penetrating the 8-bit and high-end 8-bit markets. We see above-average 16-bit microcontroller market growth throughout the next couple of years and think that Microchip is well-positioned operationally to take advantage of this segment's upsurge.

We see significant opportunity for capital appreciation for Microchip stock, driven by our view of continued growth in a fast-growing market segment and an efficient and capable operating model. We think the 3% dividend yield further supports our 5 STARS (strong buy) recommendation on the stock.

Adding Up Sales

Incorporated in 1989, Microchip develops and manufactures microcontroller and analog chips used in a wide variety of embedded control products. The company primarily offers a broad family of proprietary 8-bit and 16-bit field programmable microcontrollers under the PIC name, designed for applications requiring high performance, fast time-to-market, and user programmability. Microchip also offers high-performance linear, mixed signal, power management, thermal management, battery management, and interface devices.

Microcontrollers provided 79.3% of sales in the fiscal year ended Mar. 31, 2006 (79.7% in fiscal 2005); serial EEPROM (electrically erasable programmable read only memory) specialty memory devices, 13.5% (13.6%); and analog and interface products, 7.2% (6.7%).

The company, which has shipped over four billion PIC microcontrollers since 1990, serves more than 55,000 customers, with the 10 largest accounting for 10% of total revenue in fiscal 2006.

Global Markets

Foreign sales accounted for 74% of fiscal 2006 net sales, up from 73% in the prior year. By major region, fiscal 2006 sales came from Asia (43.8%), the Americas (28.7%), and Europe (27.5%). Approximately 17% of fiscal 2006 sales were sourced from China, including Hong Kong, and Taiwan accounted for about 10% of sales. About 65% of net sales in fiscal 2006 were made through distributors.

For a long time, Microchip operated two wafer fabrication plants in Arizona, but it consolidated operations into the newer facility in the spring of 2003. This main production plant has been operating at high utilization rates, above 95% over the last two years. In August, 2002, the company bought a wafer fabrication facility in Gresham, Ore., and started ramping production at this facility in the fall of 2003.

Microchip also has a fabrication facility in Puyallup, Wash., which is currently unequipped and is being held for future use. For back-end operations, Microchip performs assembly and test operations at its facilities in Bangkok, Thailand, and outsources the remainder to Asian contractors.

Going High Volume

In January, 2001, the company acquired TelCom Semiconductor, a maker of analog and mixed-signal semiconductors, in exchange for 9.8 million common shares. In June, 2002, it acquired PowerSmart, a fabless maker of battery management semiconductors with 40 employees, for $54 million in cash.

The company has grown sales at a 13% compound annual growth rate (CAGR) from 2002 to 2006. It has become the world's leading producer of 8-bit microcontrollers; and after commencing production of 16-bit chips two years ago, Microchip has quickly grown its customer base to the thousands, of which nearly 500 have been high-volume contracts.