When it comes to semiconductors, whatever the market offers during booms it can take away during busts, and synaptic (NASDAQ:SYNA) shareholders have been experiencing that over the last year as stocks have contributed to the weakening of consumer electronics markets. Down about a third from my last updateStocks have erased a significant outperformance over the SOX index and are down more than 70% this year.
I understand the concern about weak demand for PCs and mobile devices, not to mention weakening consumer demand for IoT. Similarly, I understand the fears that the aggressive pricing that Synaptics took in 2021-2022, which pushed gross margins above management’s previous long-term goals, will fade. Those fears are fair up to a point, but I think the stock price is now overlooking long-term opportunities in IoT that management has already shown it can successfully address. It may take another six months for investors to get back to this name, and maybe longer, but valuation here.
Major cut to guidance underscores end-market woes
The quarterly results that Synaptics reported for the fiscal first quarter (the October quarter) were not bad relative to expectations, but the company’s end markets continue to erode at an alarming rate, and the company cut guidance for the upcoming quarter. .
Revenue was up 20% year-over-year as reported and fell 6% quarter-over-quarter, below sales expectations. The IoT business grew 67% reported and 3% sequentially, and now represents more than 70% of total revenue, as the company has continued a full pivot into this segment. Mobile revenue decreased 49% year-over-year and 36% quarter-over-quarter due to lower handset demand, particularly with Korean and Chinese customers, and PC revenue decreased 26% year-over-year and 20% quarter-over-quarter due to lower phone demand. PC continue to weaken.
Gross margin improved 460 bps year-on-year and 150 bps quarterly to 62.6%, beating expectations by more than two points. Operating income was up 41% and down nearly 4% quarter-over-quarter, with margin up six points year-over-year and one point sequentially, outperforming by two points.
Taking into account the reports of companies such as amd (AMD), nvidia (NVDA), and Qorve (QRVO), investors braced for further weakness in consumer-oriented markets, and the sharp cut in guidance appears to be being viewed as of this writing more as an “offset event” than an ominous sign about the business future.
Management targeted a revenue midpoint more than 18% below October’s level, nearly 20% below published sell-side estimates for the quarter. Within that, IoT revenue is expected to decline by around 22% as demand for VR-related and other consumer IoT products continues to weaken. Gross margin guidance came in at 61.0% at the midpoint, above Street but down 160bps sequentially.
Waiting for the reacceleration and the “new normal” of the margins
The key question for Synaptics now is how much worse end-market conditions will get before they get better again. I think Synaptics could see weak sequential revenue performance through this physical year (FY’23) and possibly into FY’24. Wi-Fi 6 is a credible opportunity for Synaptics’ IoT connectivity business, and I also see increased share potential on the back of the company’s relatively new “triple-combo” connectivity product.
On the other hand, I could see that the continued weakness on mobile lasts a bit longer. OEM inventories still look high and weak demand could be exacerbated by an economic slowdown next year. On top of that, there’s already been evidence of more intense price competition in display driver integrated circuits (or DDICs) for OLED phones, and this could intensify if weaker rivals try to outbid weaker unit volumes by taking part. in the price. I’m also not particularly optimistic about the short-term outlook for the PC market, given pandemic-driven demand.
Looking more at IoT opportunities, I think the long-term outlook for edge intelligence devices in applications like smart speakers and smart home appliances is good, and I also think virtual reality is still in its infancy. But the vast majority of these indications are, in my opinion, luxuries (or toys/gadgets) at this point and susceptible to weaker consumer confidence. I see a better outlook for the automotive side of this business as I continue to expect more touch sensing and screen content in newer models.
I also want to point out a small deal that Synaptics announced just before the earnings report. The company announced that it would acquire the emza visual team of hi Max (HIMX), and given that there was no mention of the purchase price (and that Himax will continue to have access to Emza Visual’s algorithms for certain applications), it is not likely to be a significant event from a balance sheet perspective. Still, I like the idea of adding ultra-low power AI visual detection algorithms to the Katana AI SoC platform to enable human presence detection on peripheral devices.
Synaptics management has been actively reshaping the business and refocusing it on the biggest and highest margin opportunities in IoT, including connectivity, edge intelligence, and audio/video. Connectivity and edge intelligence will be increasingly valuable features in new IoT devices, and I expect significant long-term growth in VR-enabled systems for entertainment, healthcare, and industrial applications. On top of that, Synaptics has differentiated itself with high bandwidth and low power capabilities, and that’s key in the IoT market. Of course there will be competition, from the likes of silicon labs (SLAB), NXP Semiconductors (NXPI), Cirrus (CRU), and STMicro (STM), among others, but Synaptics had become a credible competitor.
I’m taking a very conservative approach to short-term modeling, expecting more sequential erosion this year and some declines to continue in the fiscal year after that. However, I do expect a significant rebound in FY25 and long-term revenue growth of around 5%. While I think the IoT business will exceed that average rate, I expect further erosion in the PC and mobile businesses over time.
Margins could be a source of weakness, as price was a strong driver last year (up 24% IoT and 16% PC), and I think it will be difficult to sustain price in a more challenging demand environment. (price is also part of my below street income expectations for FY’23 and FY’24). Management did not raise its long-term margin targets in response to excessive profits during the boom, so there is potential for a 50% erosion in gross margin and a 30% erosion in operating margin. Longer term, I continue to believe that FCF margins will hit 20%, driving long-term FCF growth into the high single digits.
The bottom line
As bright as the future may seem for Synaptics, the reality is that semiconductor stocks trade much more on a six- to 18-month outlook than on long-term discounted cash flow. To that end, I expect long-term total annual returns from here to the mid-teens, and the valuation looks too low based on minimum margins (and appropriate forward multiples for minimum multiples), but stocks can stay out please a little more time.
In the past, semi stocks have moved about six months ahead of financials, so if conditions in Synaptics’ core end markets improve in late 2023 or early 2024, the stock may remain under a cloud until mid-2020. 2023. Given the long-term growth potential of the IoT business, I think this is an inauspicious name worth considering by more contrarian-minded investors.