MW Why Microchip would rather borrow money to pay its high dividend than cut it

By Tomi Kilgore and Philip van Doorn

Chip maker's sales hit a seven-year low and are set to fall further, giving the company a 'short-term' cash flow problem

Shares of Microchip Technology Inc. were heading for a more than four-year low Friday, after the semiconductor maker said it was too early to call a bottom in its business and did not raise its quarterly dividend for the first time in four years.

The company also reported its biggest quarterly profit miss in at least five years and the lowest amount of net sales in seven years, and said sales would continue to decline in the current quarter.

The stock $(MCHP)$ shed 2.9% in afternoon trading, to put it on course for its lowest close since October 2020.

Microchip's stock has been underperforming its peers by a wide margin for about nine months. The company has faced declining demand as customers continue to work down excess supply following a "supercycle" postpandemic stock-up period.

For the fiscal third quarter, which ended Dec. 31, net sales dropped 41.9% from a year ago to $1.026 billion, just below the FactSet consensus of $1.045 billion. That was the lowest quarterly sales number reported since the $1.002 billion in sales for the quarter that ended March 31, 2018.

"Everyone would like me to call the last quarter as a bottom. However, in our view, the inventory at our customers, channel partners and their downstream customers has not fully corrected yet," Chief Executive Steve Sanghi said on the earnings call with analysts, according to an AlphaSense transcript.

The company said it expects sales for the current quarter to be $920 million to $1 billion. Sales haven't been as low as the midpoint of that guidance range since the quarter that ended in March 2017.

That weakness is giving the company a bit of a cash-flow problem.

The company said it returns all of its adjusted free cash flow to investors through dividends. But because net sales have been "depressed," the adjusted free cash flow the company is currently generating is less than the dividend.

Another issue is that the company has to make interest payments on its debt every six months. Therefore, Sanghi said that not having enough cash flow to pay the dividend is a problem that "raises its ugly head" every six months.

"So, every other quarter, we have to borrow money to pay the dividend," he said.

Late Thursday, the company said shareholders of record on Feb. 24 will be paid a quarterly dividend of 45.5 cents a share on March 7. That's the same dividend the company paid the previous quarter, snapping a 16-quarter streak of dividend hikes.

Sanghi said while there was no need to add to the dividend, he didn't want to cut it because he believes the cash-flow problem should go away "pretty rapidly" in the coming quarters.

"So because it's a short-term issue, there's no reason to do a long-term damage by cutting the dividend," he said.

At the current annual dividend rate and current stock price, the implied dividend yield for the stock has ticked up to 3.53%, compared with a yield for the VanEck Semiconductor exchange-traded fund SMH of 0.44%.

One way to estimate a company's ability to cover its dividend with cash flow is to look at its estimated free cash flow yield. A company's free cash flow is its remaining cash flow after planned capital expenditures. This is money that can be used to pay dividends, repurchase shares or to fund expansion or acquisitions or for other corporate purposes.

We can compare a company's estimated FCF yield by its dividend yield. The estimated FCF yield is the consensus estimate for free cash flow per share for the next 12 months, among analysts polled by FactSet, divided by the share price. This will show if there is headroom to raise the dividend, or at least cover the current payout with free cash flow.

Here are the 10 stocks in the VanEck Semiconductor ETF with the highest dividend yields, based on Thursday's closing prices, with their FCF yields and headroom estimates:

   Company                    Ticker    Dividend yield  Estimated forward FCF yield  Estimated FCF headroom 
   Skyworks Solutions Inc.    SWKS               4.27%                        9.56%                   5.29% 
   Microchip Technology Inc.  MCHP               3.43%                        3.05%                  -0.38% 
   Texas Instruments Inc.     TXN                2.97%                        1.76%                  -1.21% 
   Qualcomm Inc.              QCOM               2.01%                        6.85%                   4.84% 
   NXP Semiconductors NV      NXPI               1.87%                        5.18%                   3.31% 
   Analog Devices Inc.        ADI                1.77%                        4.18%                   2.41% 
   STMicroelectronics NV ADR  STM                1.34%                        4.19%                   2.85% 
   Lam Research Corp.         LRCX               1.11%                        4.37%                   3.26% 
   Universal Display Corp.    OLED               1.11%                        3.02%                   1.91% 
   Broadcom Inc.              AVGO               1.02%                        2.95%                   1.93% 
                                                                                            Source: FactSet 

Among all of the VanEck Semiconductor ETF's components, only Microchip Technology and Texas Instruments Inc. $(TXN)$ show negative estimated FCF headroom.

For Texas Instruments, dividends paid during the fourth quarter totaled $1.2 billion, while the company generated $806 million in free cash flow during the quarter, according to FactSet's calculation. The company reported having $4.38 billion in cash and cash equivalents on its balance sheet as of Dec. 31.

Former chip leader Intel Corp. had slashed its dividend by two-thirds in February 2023 after years of underperformance in an effort to improve "financial flexibility." Then in August 2024, Intel suspended its dividend as part of a $10 billion cost-cutting plan.

Intel's stock is currently trading about 27% below where it was when the dividend was first cut in February 2023, showing Intel has long-term rather than short-term issues.

Separately, Microchip said it swung to a fiscal third-quarter net loss of $53.6 million, or 10 cents a share, from net income of $419.2 million, or 77 cents a share, in the same period a year ago.

Excluding nonrecurring items, such as restructuring costs and the effects of share-based compensation, adjusted earning per share of 20 cents missed the FactSet consensus of 27 cents. The margin of that miss was the widest in at least five years, based on available FactSet data.

Of the 27 analysts surveyed by FactSet who cover Microchip's stock, no fewer than 15 cut their price targets after the earnings report.

But the current average stock-price target of $65.48, down from $78.43 at the end of January, implies about 30% upside from current prices.

Two-thirds of the analysts - 18 - are bullish on the stock, while eight are neutral and one is bearish.

-Tomi Kilgore -Philip van Doorn

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February 07, 2025 13:28 ET (18:28 GMT)

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