Markman Capital Insight

Buy Monolithic Power Systems To Exploit The Chip Shortage

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The use case growth for semiconductors is getting lost in endless headlines about shortages and cyclicality. It is a big opportunity for investors.

The controlling shareholder at GlobalFoundaries on Friday made a stunning statement. Khaldoon Al Mubarak expects sales of semiconductors to reach $2 trillion by the middle 2030s. The sector is currently tracking at a $500 billion clip.

Investors should consider buying Monolithic Power Systems (MPWR) into the current weakness.

Let’s be clear. End buyers are the reason for the current semiconductor shortages. Enticed by just-in-time inventory accounting, many of the world’s biggest semiconductor buyers cut orders in early 2020 when the global pandemic landed in North America.  In hindsight, it was a catastrophic mistake.

Microprocessor foundries, the companies that manufacture chips on a contract basis did not sit idle waiting on new orders from the likes of General Motors (GM) and Toyota Motors (TM). Overwhelming demand from other buyers in consumer electronics, appliances, computers and smartphones was more than enough to fill the void.

It’s the untold story of semiconductors.

While investors are focused on shortages and the prospect chipmakers may build too much capacity, the real problem for the foreseeable future is too much demand. Semiconductor use cases are growing exponentially. 

What is So Great About Monolithic Power Systems?

Monolithic Power Systems designs the tiny integrated circuits used to control power supply. These chips are used primarily in cloud computing infrastructure, telecommunications, consumer electrics, industrial, and automotive applications. And they are essential.

The company has a distinct advantage over competitors because its modules integrate all of the power functions into a single silicon die. Being ultracompact is a big deal in when space is at a big premium on boards that are becoming denser and smaller. This is advantage is showing up in contract wins and steady sales growth.

Revenues in 2020 reached $844 million, up 34.4% year-over-year. According to FactSet, analysts expect sales will balloon this year to $1.2 billion, a rise of 41%. Profits and dividends have followed.

Monolithic Power is an exceptionally well-run business.

At 56.2%, its gross margins are 14% better than the industry average. And profit margins beat the industry by 200%. Monolithic reported in November that earnings soared to $77 million, up 28.3% from a year ago. Later in the month Michael Hsing, chief executive, announced a 60-cent quarterly dividend.

More importantly, Hsing is furiously building capacity to support $2 billion in annual sales as the chips the company produces find more uses. He points out that new cars use 3x the number of chips. Electric vehicle transition will see that number grow even further.

That is also the story being told by Al Mubarak. As manager of the Abu Dhabi state investment fund he oversees $240 billion in assets. His fund is also the largest shareholder in GlobalFoundries, a major chip maker.

Mubarak told CNBC on Friday that Global will continue to build new manufacturing facilities in front of industry sales that should quadruple during the next 15 years.

It makes a lot of sense. Chips are in everything these days as devices like washings machines and toothbrushes become smart. Some of this is connectivity.

Adding devices to the so-called internet of things has been a big push for years. Manufacturers of consumer products are see connectivity as an engine for a new upgrade cycle. Meanwhile industrial companies are gearing up for a much bigger productivity play. This means more connected factory robots. It also means next generation sensors, another fertile space for semiconductor growth.

Monolithic Power plays in all of these businesses.

The company sells its power supplies to Asian firms that make cell phone chargers, game console makers and the big tech companies building bespoke computer boards for giant server farms. Monolithic is also building out a considerable automotive business.

Through parts suppliers Delphi, Bosch, Panasonic Automotive, Magna and Mitsubishi Electric, Monolithic reaches end customers such as Ford (F), Nissan, BMW, Mercedes, General Motors, Volvo, Toyota, Volkswagen (VWAGY) and Kia.

At a price of $482.99, Monolithic Power currently trades at 56.7x forward earnings and 19.8x sales. While this may seem pricey, keep in mind that shares have traditionally traded at a premium to the market and its competitors.

Longer-term investors should consider buying a pullback into the $460 range. Based on sales growth, the stock could trade to $600 in 12 months, a gain of 30% from the $460 entry point.