Microchip shares slide pre-market as BofA cuts rating to 'underperform'

Investing.com -- Shares of Microchip Technology (NASDAQ:MCHP) were trading over 3% lower in pre-open trading on Monday following a downgrade by BofA Securities to “underperform” from “neutral.” 

The brokerage cited multiple challenges, including weak recovery prospects, elevated inventory levels, and high valuation, as reasons for the lowered outlook.

Analysts at BofA Securities said that Microchip has faced its second earnings miss in a month, alongside a recent CEO transition and the closure of an Arizona fabrication facility. 

Additionally, the company plans to return funds from the CHIPS Act, further reflecting subdued near-term demand recovery. These developments, according to the report, signal continued headwinds for the company.

The downgrade also reflects concerns about broader industry dynamics and specific vulnerabilities within Microchip's business. 

The company is reportedly more exposed to industrial microcontroller markets, which have experienced unsustainable pricing trends and take-or-pay contracts that have exacerbated excess inventory issues. 

BofA Securities noted that quarterly sales in this segment have dropped by more than 50% since their June 2023 peak.

Adding to the pressure, analysts pointed out that the company’s inventory stands at over 276 days, raising potential write-down risks. 

The muted earnings outlook is compounded by limited leverage in both manufacturing operations and operating expenses, despite prior cost-cutting measures, including employee salary reductions.

Microchip's current valuation also played a key role in the downgrade. BofA Securities stated that even if the company manages a doubling of annualized earnings from $1 per share to $2-$2.50 by 2026, it would still trade at a price-to-earnings multiple of 25 to 30 times, compared to its historical median of 17x.

While the brokerage said there are some upside risks, such as a faster-than-expected macroeconomic recovery and potential management improvements, it also said  that these remain speculative at this stage. 

For 2026, BofA estimates a price target of $65, down from the previous $80, based on a 34x price-to-earnings ratio at the higher end of the historical range.