Microchip Technology

Microchip Technology reported fiscal first-quarter revenue of $1.485 billion, up 38% year over year and above the high end of guidance. Microchip expects September-quarter revenue of $1.6035 billion, which would be up 41% year over year and ahead of FactSet consensus estimates.

Why it matters: Like its peers, Microchip is firing on all cylinders, with strong demand for its broad base of semis in the industrial and automotive end market, while prospering from structural growth in chips going into data centers. We're impressed with Microchip's adjusted gross margin expansion to 64% in the June quarter and the firm's forecast of 66.5% for the September quarter, to the point that management cautioned that its 65% long-term target remains intact. Microchip is passing price increases on to its customers, which may add a modest boost to September margins. However, Microchip is also seeing tightness in supply. Like in any cyclical upturn, Microchip will likely sell almost everything it can make next quarter.

The bottom line: We maintain our $80 fair value estimate for wide-moat Microchip. Shares rose about 9% after-hours on the strong report, and we view shares as fairly valued. After one of the worst cyclical downturns we can recall, demand for Microchip's products has roared back under CEO Steve Sanghi. We like the firm's end market diversification, with data center and aerospace/defense standing out as the most intriguing long-term opportunities for the firm.

Coming up: Microchip's rosy forecasts are supported by an increase in chips sold through the distribution channel, bookings well ahead of current chip shipments, and an overall improvement in demand across several end markets. In addition to the robust gross margin expansion, Microchip anticipates operating expense restraint, which should contribute to 39% adjusted operating margins in the September quarter, which puts the firm well on its way toward its 40% long-term target.

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Our fair value estimate is $80 per share, which implies fiscal 2027 (ending March 2027) and fiscal 2028 price/adjusted earnings ratios of 24 times and 17 times, respectively.

Microchip prospered from the global chip shortage as it could sell virtually every chip it made in fiscal 2022 and 2023, achieving growth of 25% and 24%, respectively. However, Microchip over shipped to its customers to some extent during these good times. This led to a 9.5% revenue decline in fiscal 2024 and a whopping 42% decline in fiscal 2025. We do not believe that such a slowdown had much to do with lost market share or lost content within electronics devices, although the severity of the decline means that structural headwinds can’t fully be ruled out either.

Microchip is now on the road to recovery as it generated 7% growth in fiscal 2026. We anticipate a roaring recovery in fiscal 2027 and fiscal 2028 with 31% and 16% growth, respectively. We think this snapback brings Microchip toward “normal” revenue levels. In the longer term, we project average midcycle sales growth of 8% per year, about in line with the company’s long-term target of “industry growth plus.” We anticipate that Microchip will achieve solid growth in higher-end MCUs, analog, data center, and FPGA products.

Microchip’s adjusted gross margin peaked at 68% in fiscal 2023. Lower sales levels caused this margin to dip to 57% in fiscal 2025 and 58.5% in fiscal 2026. In the medium-term, as the company’s inventory correction subsides and Microchip rightsizes its manufacturing footprint and achieves improved factory utilization, we think the company can get back to a 64% adjusted gross margin in fiscal 2027 and beat its long-term target of 65% in fiscal 2028 by achieving 66%. Longer-term, we model adjusted gross margin going as high as 69% in fiscal 2031.

Microchip also reached peak adjusted operating margin of 47% in fiscal 2023, but it has since fallen to 24.5% in fiscal 2025. We model a recovery to 37% in fiscal 2027. We again think Microchip will beat its long-term target of 40% in fiscal 2028 by reaching 43%, and we think the margin can get to 50% by fiscal 2031.

We believe that Microchip has a wide economic moat. Moats for analog and microcontroller chipmakers, such as Microchip, tend to come from intangible assets around proprietary chip designs and manufacturing expertise, as well as switching costs that make it difficult to swap out analog and MCU chips for competing offerings once they are designed into a given electronic device. Given Microchip’s record of stellar profitability in recent years and ability to retain its leadership position in MCUs while expanding its analog business, we think it is more likely than not that the company will earn on excess capital over the next 20 years.

Looking at intangible assets, leading analog and MCU chipmakers face stringent quality requirements in some end markets, such as the automotive space, for example, where defects can only be tolerated as infrequently as one part per million. Although the analog and MCU chip industries are quite fragmented, it would be difficult for any new entrant to achieve this level of quality while still satisfying high-volume production. Furthermore, Microchip’s 8-bit MCUs are based on its proprietary PIC architecture, and although the MCU industry is fairly fragmented and MCUs, by definition, perform simple processing functions, we think there is a bit of uniqueness to Microchip’s designs. We also see similar distinctiveness in the firm’s AVR-based MCUs acquired from Atmel.

Regarding switching costs, analog and MCUs tend to make up only a small portion of a product's bill of materials, so purchasing decisions tend to be based on performance rather than price, helping Microchip retain pricing power. Once electronics manufacturers select an analog chip or MCU, they tend to stick with the chip for the life of the device because it is costly to redesign a device in order to swap in a competing chip that might not necessarily be compatible with the rest of the product. We think this is especially important for Microchip, as engineers become accustomed to the firm’s design tools associated with its MCUs. Furthermore, automotive, industrial, and communications infrastructure customers, in particular, are unlikely to choose an inferior chip in order to save pennies on the cost of a piece of equipment worth tens of thousands of dollars.

Microchip takes this switching cost benefit one step further by concentrating on end markets where product lives are measured in decades, as opposed to the increasingly short lifecycles associated with consumer devices like PCs or handsets. Microchip is also well diversified and is not overly reliant on any single customer or end market. Firms that can sell in lower volumes to a broader base of customers also don't have to make the types of price concessions seen by those that sell into the handset or PC markets, for example, where chip orders are made in the hundreds of millions, rather than the thousands.

Ultimately, we think these intangible assets and customer switching costs enable firms like Microchip to benefit from long useful lives associated with certain chip products. In turn, chipmakers like Microchip tend to benefit from lower ongoing R&D and capital expenditure investments, which contributes to healthy returns on capital for shareholders.

Microchip sells to tens of thousands of end customers, so it is not overly dependent on sales to any one client or market segment.

Microchip is well-positioned to take advantage of increasing processing power and rising chip content in a host of devices, such as automotive and industrial equipment.

Microchip has typically done a good job of bracing itself during downturns, including pay cuts and shutdowns, to maintain healthy profitability.

The Chinese government is striving to build out an ecosystem of chipmakers, and it’s likely that some Chinese upstarts will emerge as competitors to Microchip in the years ahead.

Microchip is the market share leader in 8-bit MCUs but trails a couple of other firms in 16- and 32-bit MCUs, as well as analog semis.

Microchip has done an exceptional job of integrating M&A targets in recent years but has leveraged up the balance sheet to do so.