Why MACOM Stock is a Buy (NASDAQ:MTSI)

In the year that has passed since MACOM called (NASDAQ: MTSI) breakout, the semiconductor company moved above $75.00 to close below $55. The MTSI is down 12.5%, underperforming the -2.96% decline in the S&P 500 (SPY). Outraged the semiconductor sector falls alongside the Nasdaq (QQQ) bear market, why are investors giving up?

MACOM reported strong second quarter results

In the second quarter, MACOM posted EPS of 68 cents (non-GAAP). Revenue increased 9.7% year-on-year to $165.15 million. For the third quarter, the company expects revenue of up to $172 million in the third quarter. It will pay between 68 cents and 72 cents.

Unlike many tech companies like PayPal (PYPL), Snowflake (SNOW) or Coinbase (COIN) with generous stock compensation, MACOM only paid out $10.27 million. This represents 6.2% of turnover. Its non-GAAP figure also excluded an amortization charge of $8.05 million.

During the quarter, the company reported non-GAAP free cash flow of $35.4 million. This included $7.1 million in capital expenditures.

Opportunity

MACOM benefited from strong growth in the telecom sector. This will continue in the third and fourth quarters. Industrial and Defense and Data Center will grow from last year. At a minimum, Chairman and CEO Steve Daly expects revenue to grow by at least 10%. The company has an order-to-invoice ratio of approximately 1.2 times. The markets are not rewarding the company with its strong overall performance.

Investors are likely worried that the data center business segment will face disruption due to supply constraints. Fortunately, MACOM’s PAM4 and 400G product enjoys high demand. To expand its addressable market, it will get involved in high performance computing markets, which require higher throughputs. Long-term demand trends are so strong that investors should model higher growth beyond 2022.

Below are the assumptions for a five-year discounted cash flow model: revenue outflow.

Metric	Interval	Conclusion
Discount rate	8.8% – 7.8%	8.30%
Terminal revenue multiple	5.2x – 5.8x	5.5x
Just value	$58.73 – $66.86	$62.72
Upside down	7.1% – 22.0%	14.40%

finbox template

Investors can assume that income increases by at least 10% per year:

(USD in millions)		Entrance screenings
Exercises ending	21st of October	October 22	October 23	October 24	October 25	October 26
Revenue	607	668	741	830	921	1,023
% Growth	14.50%	10.00%	11.00%	12.00%	11.00%	11.00%
EBITDA	151	167	185	207	240	307
% of sales	24.90%	25.00%	25.00%	25.00%	26.00%	30.00%

finbox template

Telecommunications is a positive driver for MACOM’s business. It has analog integrated circuits for the front transport. Additionally, it sees traction for its lightwave components, including the laser and photodetector. Investors could model an acceleration in the rate of revenue growth from 2023. By next year, the industry should benefit from the standardization of the supply chain.

Risks

MACOM has built its market share in the telecommunications sector over the past 18 months. Traction for its CWDM6 and BiDi platforms is building. Moreover, it has a competitive advantage, thanks to its 4-inch binary semiconductor indium phosphide.

The shortage of electro-optical modulated (“EML”) lasers could slow down MACOM’s efforts in the segment. Yet they have very high prices. Revenues will once again increase as the company succeeds in penetrating other industrial markets requiring EMLs.

Minimum competition from China

MACOM faces competition from Chinese companies. Fortunately, smaller companies have discontinued some of their product offerings. MACOM’s lower operating cost advantages will allow it to enter these markets. For example, it will offer analog solutions to customers. This includes lasers and a transimpedance amplifier used on the receiver side.

Demand in industry and defense could slow. Fortunately, CEO Steve Daly said the I&D environment hasn’t changed. Customers demand advanced technologies for their platforms. For example, the company recently announced a major contract with the US Department of Defense on April 26, 2022. It will develop a high-power transmitter. This 45 kilowatt radio frequency transmitter uses gallium nitride semiconductor and antenna beamforming technology.

Stock category and your takeaways

MACOM has a strong factor rating on profitability and growth. Its valuation is correct:

MACOM was among the semiconductor stocks that sold off. Once investors look for heavily discounted and battered stocks, they will recognize MACOM’s profitability profile.

Regardless of stock market conditions, MACOM is a stock that investors should view as weak. It has strong bookings and a healthy product pipeline. It has operating cost advantages over Chinese competitors. Markets that have sold MTSI stock in a panic will want to buy back the stock before it rebounds.