MACOM Technology Solutions: Why The Stock May Not Be Done Yet (NASDAQ:MTSI)

MACOM Technology Solutions (NASDAQ:MTSI), a designer and manufacturer of high-performance semiconductor solutions for the telecommunications, industrial, defense and datacenter markets, has seen its stock lose some steam in the last few months. MTSI still retains most of the gains from the preceding rally, but the stock seems unsure as to what to do next after the recent pullback. Why will be covered next.

A long rally has come to an end, or has it?

A previous article from last June mentioned how MTSI was in an uptrend, which made it relatively easy to guess in which direction the stock was likely heading next. On the other hand, the article cited the amount of time the stock had gone up, which argued for a correction in the stock, a large increase in short interest and the fact that multiples had increased faster than earnings as reasons for rating MTSI a hold after concluding that a change in direction could be near.

It is too early to say in a definite way, but the chart above suggests the prior article may have been on to something by thinking that a change in direction could be near. Note how in the chart. the stock has struggled to go higher after peaking in July. The stock hit a high of $118.77 on July 9, but then declined until it hit a low of $90.01 on August 5. More recent action has seen the stock basically see-saw around with no real change.

What to make of the recent price action?

The recent sideways price action follows a long move upwards in the stock. Some may therefore be curious to know whether the recent struggles in the stock are just a temporary pause on the way higher, or whether the preceding rally has come to an end. It is difficult to say what will happen in the future, but, at this time, there is reason to believe it is likely a case of the former.

Keep in mind, the price action in the past two months or so, starting in mid-July, was negatively affected by a range of potentially negative developments. This included the possibility of additional trade restrictions on China, a reigniting of the China-U.S. trade war, an escalation of the fighting in the Middle East and increased volatility in the forex market. All these put downward pressure on the stock market, which likely affected MTSI as well.

However, while it is not correct to say that these issues are no longer a potential problem, they have not become as much of a problem, at least as of right now. As long as the aforementioned issues do not blow up, the market can look past them as something not to be overly concerned about. If this happens, MTSI could benefit from less investor concerns, which could help the stock if buyers become less worried and get back to looking for stocks. This could include MTSI.

There is more. The chart above shows how the recent peak of $118.77 in July 2024 was the culmination of a long upwards move in the stock that began two years earlier in July 2022 with a low of $42.85. More significantly, the 38.2% Fibonacci retracement of $42.85 to $118.77 is $89.77. This is close to where the stock recently bottomed at $90.01 on August 5.

The stock bounced at a known retracement level, which would not have happened if buyers did not step in to send the stock price higher. This means bulls remain convinced the stock has room to go higher, or they would not have bought when they did to make the bounce happen. This suggests the rally may not yet be dead, but could still have some life left.

What to make of the shorts pulling back?

There is another data point that points in the direction of the recent sideways action being a temporary pause and not an end to the rally of the last two years or so. As mentioned in the prior article, short interest jumped to a new high in June, but according to the most recent data from the Nasdaq, short interest has since dropped to 3,348K shares, as of 8/30/2024, after steadily rising earlier in the year. This translates to a short float of 5.68%.

It is also significantly less than in June when short interest reached a high of 4,739K on 6/30/2024, which was more than twice as high as on 9/15/2023 when short interest stood at 2,318K. Short interest has yet to drop down to the levels of a year ago, but the recent short covering following the correction in the stock suggests a significant number of shorts, although certainly not all, do not believe the stock price is likely to drop much further. If they did, they would not have pulled back.

Earnings growth favors the bulls over the bears

Shorts may have decided to back down with earnings at MTSI on the rise. MTSI went through somewhat of a downturn, which led to a down year in FY2023, but both the top and the bottom line have been going up more recently. The table below shows how the numbers have generally moved higher in the most recent quarter or Q3 FY2024.

Keep in mind, the recent improvement got an assist from the acquisition of the radio frequency unit from Wolfspeed (WOLF), a cash and stock transaction worth $125M. MTSI finished Q3 FY2024 with cash, cash equivalents and short-term investments of $521.5M, offset by $447.99M of long-term debt on the balance sheet.

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Source: MTSI Form 8-K

The expansion is expected to continue. Guidance calls for Q4 FY2024 revenue of $197-203M, an increase of 33% YoY at the midpoint, and non-GAAP EPS of $0.70-0.76, an increase of 30.4% YoY at the midpoint. The latter was somewhat better than consensus expectations of $0.72.

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Source: MTSI Form 8-K

MTSI does not come cheap

MTSI has earned $1.83 on revenue of $528.87M in the first three quarters of FY2024 and Q4 guidance suggests MTSI will end FY2024 with non-GAAP EPS of $2.56 on revenue of $728.87M. This implies a P/E ratio of 39.5x for MTSI with the stock price currently at $101.14 as of September 12, which is close to twice as high as the median in the sector at 23x.

At the same time, earnings are widely expected to continue to grow in FY2025. Wall Street estimates see non-GAAP EPS of $3.06 at the low end and $3.82 at the high end of estimates. The midpoint or $3.44 implies a YoY increase of 34.4% in non-GAAP EPS in FY2025, which would convert to a P/E ratio of 29.4x, assuming the stock price remains where it is currently at.

Keep in mind the above is using non-GAAP, which does not account for some expenses, including stock-compensation expense. If GAAP is used, which does include all these expenses, multiples go up quite a bit. For instance, MTSI has earned $0.99 TTM in terms of GAAP, which translates to a P/E ratio of 102.2x.

MTSI may be too exposed to the defense industry

The above may cause some to take a step back. In addition, some investors may have mixed feelings about the fact that MTSI is rather heavily tied to defense spending. In Q3 FY2024, industrial and defense accounted for $90.9M out of $190.49M in total revenue. In fact, the defense sector seems to be the best performing sector for MTSI right now. Many other end markets are not in good shape. From the Q3 earnings call:

“I think it really depends on the market. We see some end markets that we believe there’s limited or no demand. And so it’s not an issue of clearing channel inventory. It’s the fact that there’s just no demand. There’s no catalyst either through CapEx spending or infrastructure deployments. And so there’s many markets that are down, and we would expect them to stay down until there’s a catalyst. And so – then we have other customers that are extremely busy, not only ramping up existing programs, but launching new programs. And I would say that applies to many of our Defense customers. We are extremely busy in supporting a whole wide range of applications in the defense industry. The industrial market is, I would say, similar to your comments, it really depends in terms of what those particular customers are producing, whether it’s test equipment or factory automation or sensors for automotive applications or traffic tolling. So it really depends.”

Source: MTSI earnings call

On the one side, demand from customers in the defense sector is strong, offsetting weakness in other sectors. On the other hand, people may have various misgivings about the defense industry, which could be extended to MTSI due to its close ties. Defense spending, for example, tends to be stable in terms of demand, which helps MTSI, but which could also raise objections from those who have an issue as to how end products are being used around the world.

Investor takeaways

MTSI has rewarded those who were long for a long time. The stock moved upwards for a full two years, but the last couple of months it has struggled to go higher. MTSI hit its most recent high in July, but there have been no new highs since then. Instead, the stock has gone up and down, seemingly unsure of what to do next. The direction of the stock has become harder to guess, in contrast to not so long ago when it was easier due to the gradual upwards move upward in the past two years.

Some may conclude the rally has ended with the recent price action and no new highs in months. However, there are several clues that suggest the rally may not yet be dead, but could still be alive. Short interest, for instance, is going down. This would not be the case if shorts thought the stock is more likely to go down than up. On the contrary, short covering is what happens if the stock is deemed to be getting ready for a move higher.

The recent sideways action after a major move higher looks more like a temporary pause than an end to the rally. The stock was arguably due for some consolidation time after spending so much time going up. The fact that earnings are growing at a solid clip also argues in favor of a stock that has yet to reach its peak. If not for recent events, which negatively affected stocks, the stock might still be moving up like in the past 2+ years.

It is tempting in some ways to be long MTSI since the company has a number of good arguments in its corner, but I am neutral on MTSI, mostly because of where multiples are. MTSI offers growth, but at a price. Multiples are high, especially if one prefers to use the more stricter definition of earnings used by GAAP. The trailing P/E multiple, for example, is in the triple digits.

In the end, it comes down to how much one is willing to pay for growth. MTSI offers growth, but it won’t come cheap. When multiples are this high, much, if not all, of the expected growth has been priced into the stock. That is no problem if earnings go up, but it could become an issue if earnings do not grow as expected. The latter is not impossible.

Still, the most likely direction for the stock to take next is up. The recent struggles in the stock are likely a temporary pause before the stock proceeds to go higher. There is, after all, a reason why so many shorts have started to cover. At this time, unless something changes, the path of least resistance for MTSI is still pointing higher.