Is SMTC a Buy?

Shares of Semtech (NASDAQ:SMTC), a semiconductor manufacturer specializing in signal hardware, optical connectivity and other semiconductors needed for fast, modern internet connections, have risen by over 110% year to date.

But will the company’s list of products that span everything from low-power RF chips to cutting-edge AV solutions provide sufficient impetus for the share price to keep running?

Why Have Semtech’s Revenues Exploded? 

By far the biggest reason for SMTC’s upward ride stems from stellar top line performance. In 2020, the company generated full-year revenues of $596 million. The current trailing 12-month total, by contrast, is $815 million.

This trend of higher revenues is expected to continue into Q3. In Q2’s report, Semtech detailed quarterly revenues of $215.4 million, up from $206.1 million in Q1. Q3’s outlook is slightly higher still, with $233 million +/- $5 million in revenue expected.

Several technological trends have supported this steady top-line growth. In particular, Semtech has benefited from the advent of smart home and IoT technologies. Both the company’s infrastructure segment and its 5G products have seen higher demand due to the need for faster data transfer speeds in homes and businesses.

Given that this trend not showing any signs of slowing down anytime soon, Semtech appears to be a very solid long-term bet on the Internet of Things.

The Problems of Net Income and Valuation

Despite excellent growth, Semtech also has its share of problems. Chief among these is net income, which has slipped sharply into negative territory since late 2022.

In the trailing 12-month period, the company lost $873 million. Even on a non-GAAP basis, profitability is slim. The company reported adjusted earnings of $0.23 per share in Q2, relatively low for a stock that is trading at well over $45. The pricing of SMTC shares appears to imply a fairly high level of forward growth.

This leads to another problem with SMTC, which is its valuation. Trading at 4.1 times sales while losses continue, there is a decent chance that Semtech could be a bit overvalued.

With that said, there’s also a counterargument in the form of the company’s strong cash flows. Semtech generates about $13.20 in cash flow per share, giving it a price-to-cash-flow ratio of 3.6.

While the company will need to be able to return to reliable profitability to support its share prices in the long run, this strong cash flow has the potential to support an elevated share price in the near term.

A final issue for Semtech investors is the currently low return on invested capital. At -8.4%, the company’s ROIC is anything but inspiring.

Continued revenue growth may very well boost this number into positive territory and eventually result in a strong return for investors but, for the moment, Semtech doesn’t appear to be able to generate positive returns from its reinvested cash.

A Look at Semtech’s Financial Health

On the balance sheet, Semtech holds a reserve of cash and cash equivalents totaling about $116 million which is reasonable but not stellar.

A closer look reveals a somewhat less rosy picture. Semtech has about $1.19 billion in long-term debt, an amount that resulted in a $28.6 million interest expense in Q2 alone.

As a result of this debt load, Semtech has a shareholder’s deficit of about $141.4 million, which accounts for the stock’s negative book value of -$1.88 per share.

This doesn’t mean, however, that Semtech is inherently financially unhealthy. To begin with, the company has paid down about $178 million in long-term debt since the start of the year, suggesting that management has an eagle-eye focus on strengthening the balance sheet.

Semtech is also generating ample cash flows that should allow it to repay debts comfortably. So, the financial position isn’t perfect, but it also doesn’t appear to be an undue risk.

Is SMTC a Buy?

SMTC stock’s median price target is $52.50, about 13.3% above the current price and making it a Buy as a result.

This normally wouldn’t be unusual because the stock market broadly is expected to rise in the forward 12-month period due to lower interest rates and ongoing earnings growth. But SMTC has already run up so far that additional room for upward movement reflects quite a bullish view of the company.

Additionally, 11 of the 12 analysts covering the stock currently rate it as a Buy. This long-term growth view is well-reflected in analyst forecasts for SMTC stock. 

At the end of the day, SMTC’s prices will rise or fall based on its ability to continue delivering strong growth. Luckily for shareholders, analysts project good growth in both earnings and revenues. EPS is expected to grow by about 20% annually over the coming 5 years, and revenue growth appears likely to remain in low double-digit territory.

Semtech also has a decently strong moat due to its list of massive customers. Companies such as Apple, Sony and Samsung all buy Semtech’s products. With such large, stable customers, it’s likely that Semtech will remain a major player in the semiconductor space for the foreseeable future.

Semtech has its risks, but it is also a strong play on the future of 5G wireless and the ever-expanding Internet of Things. Demand for fast, large-scale data transfers only appears set to rise in the coming years. With the number of IoT devices expected to more than double by 2030, Semtech’s connectivity products are likely to stay very relevant.

Because Semtech is showing signs that it may level off after its long and dramatic run, current investors may want to assume a somewhat long horizon for returns on SMTC.

The stock is likely to continue moving upward during the coming 12 months, but it’s unlikely to come anywhere close to replicating the triple-digit returns it has managed so far this year.

With that said, Semtech could be a long-term compounder if revenues continue rising and the company can gradually move back toward profitability.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.