Semtech Corporation: Upcoming Report Could Be A Make Or Break Moment

Semtech Corporation (NASDAQ:SMTC) has staged a turnaround of sorts in the last few months. The stock is still nursing most of the losses stemming from a long decline that began roughly two years ago, but it has recovered some of those losses recently. However, while some may conclude the bottom is in for SMTC, it remains to be seen if that is indeed the case. The stock has started to waver, which is why the next earnings report could become a make-or-break moment. Why will be covered next.

The stock has fallen by a lot

The chart below shows how the last two years or so have not been kind to SMTC. A past article from early 2022 details how far the stock had fallen at that time. There were moments where it seemed the stock might have found support to stem the decline, but the stock kept falling, going from a high of $94.92 in November 2021 to a low of $17.82 in May 2023.

A stock that has spent as much time in a long downtrend as SMTC is almost certain to draw the interest of shorts looking to capitalize. SMTC was no exception in that regard. Short interest rose as the stock fell, especially in the second half of 2022 after the stock lost half its value from July to September. According to the Nasdaq, short interest reached a peak of 8,879K shares on May 31, 2023.

However, the stock has done better in the last three months. Short interest has fallen accordingly, declining to 7,109K as of August 15, which translates to a short float of 11.3%. Still, it’s fair to say there are a lot of people out there who believe the stock is heading lower. While a substantial number of shorts have closed their positions after May, most have not. This suggests that the majority of the shorts believe the bottom is not in.

The stock came close to doubling from the May 2023 low to the July 2023 high, but the stock has wavered in the weeks since then. The rally might have caused some to think the bottom was in, but the last few weeks might have led some to doubt whether the bottom is truly in and if the recent rally was just a temporary bounce and nothing more.

There is an argument to be made that the stock has further to go and that the bottom is not yet in. For instance, if we assume the decline from the November 2021 high to the May 2023 low was actually a retracement of the uptrend starting in October 2015 with a low of $14.04 to the November 2021 high of $94.92, then the May 2023 low of $17.82 came up short as it did not complete the 100% Fibonacci retracement that you would ideally want to see. Based on this, the stock might have to go lower than the May 2023 low in order to complete a 100% retracement. Quite a few may be betting on this, as suggested by the short float.

The bottom is in or maybe not

The stock has bounced around in recent months. The stock went from a May 2023 low of $17.82 to a July 2023 high of $29.97, only to turn south once more to close at $25.31 as of August 25. It’s therefore worth mentioning that SMTC is scheduled to release its next report on September 7. With the stock showing signs of wavering, the Q2 FY2024 report could be the catalyst that determines whether the stock continues to recover losses from the last two years or whether it continues its recent fall, possibly going so far as to break the May 2023 low.

The consensus is that SMTC will report non-GAAP EPS of $0.02 on revenue of $237.5M on September 7, which is in line with the midpoint of guidance from SMTC as shown below. Keep in mind that Q2 FY2023 precedes the acquisition of Sierra Wireless (SWIR) by SMTC in January 2023, an all-cash transaction with an enterprise value of about $1.2B. This is skewing the YoY comparisons.

The acquisition can be seen in the balance sheet where long-term debt reached $1,336.6M in Q1 FY2024, up from $181.8M in Q1 FY2023 and partially offset by cash and cash equivalents of $164.2M. The income statement is also affected by various transaction, integration, and restructuring charges associated with the Sierra acquisition.

For instance, the aforementioned charges and intangible amortization are the chief reasons why SMTC earned $0.02 in terms of non-GAAP, but lost $0.46 in terms of GAAP in Q1 FY2024. Similarly, the big drop in margins is mostly due to the addition of Sierra. Note also that while revenue increased QoQ and YoY in Q1 FY2024, it declined on an organic basis since revenue was only around $100M if contributions from Sierra are excluded. The table below shows how the numbers have changed in recent quarters.

Source: SMTC Form 8-K

What the market will be keeping an eye on

It should be noted that the $0.02 earned in Q1 FY2024 was $0.10 higher than what consensus estimates had expected, part of the reason why the stock rallied after the Q1 FY2024 report. SMTC was able to accomplish this through various means, including limiting discretionary spending and synergies with Sierra that were proceeding ahead of schedule.

Nevertheless, SMTC faces a weak demand environment, resulting in falling sales that is partially masked by the Sierra acquisition. The market will thus be on the lookout for further updates from SMTC whether demand is getting better, as SMTC alluded to in the last report. Bookings have increased, a positive sign. From the Q1 FY204 earnings call:

“Both net revenue and EPS were better than guidance, while inventories remained high, Q1 bookings for the organic Semtech business were up sequentially, increasing our confidence that the organic Semtech business has stabilized, albeit, at much lower levels. In Q1, our Signal Integrity Product Group revenue was down 32% sequentially and represented 18% of total revenues. As expected, all our infrastructure businesses were very weak in Q1.

Our China PON and base station businesses were especially weak in Q1, as overall demand softened and inventories remained high. Our hyperscale data business -- data center business was also weak in Q1, but we are expecting this business to rebound modestly in Q2 as inventories reduce. We are anticipating a strong second-half performance from our data center business, driven by our North American design wins.

A transcript of the Q1 FY2024 earnings call can be found here.

Why SMTC could be at a make-or-break moment

The stock has rallied in recent months in anticipation of further improvement at SMTC. However, if SMTC does not deliver what the market is looking for, which is continued improvement, the stock could easily return all its gains from the last three months and then some. Multiples could become a problem.

SMTC has earned $2.01 in the last 12 months on a non-GAAP basis, which implies a trailing non-GAAP P/E ratio of about 12.6 with the stock priced at $25.31. However, if let’s say revenue stays flattish at around $240-250M with gross margin of around 50%, then earnings for the next 12 months is projected to be around $0.60. This implies a forward P/E ratio in the forties. Keep in mind, this is if you are being optimistic and SMTC keeps improving, albeit at a slow pace.

A P/E in the forties may already be too high for many, but if SMTC encounters additional headwinds and the quarterly results suffer as well with lower earnings, then P/E ratios could go even higher. Note that this is for non-GAAP, which excludes expenses like share-based compensation. In terms of GAAP, the numbers look worse, since SMTC is in the red in terms of GAAP. Add in the fact that SMTC is dealing with over a $1B of debt, and it becomes easier to understand why shorts remain interested in SMTC.

Investor takeaways

I am neutral on SMTC. On the one hand, the stock has rebounded off the May 2023 lows, resulting in the stock appreciating by more than half, but the stock is showing signs of faltering once again. SMTC is weighed down by a drop in demand at a time when it needs to digest the Sierra acquisition, which also blew a hole in the balance sheet to the tune of $1.2B.

If the stock is to continue higher, it may need a catalyst to power it higher. The Q2 FY2024 report could decide whether the stock continues the rebound off the lows, or whether the shorts are proven right to be sticking with SMTC for the most part. While SMTC is seeing weak demand all around, the previous report showed enough to warrant the belief things are improving and the worst is over. This allowed the stock to move higher and the Q2 report will need to build on this and deliver more improvement or the shorts will be emboldened to double down and push the stock lower, perhaps below the May 2023 low.

Bulls and bears alike should thread with caution in the next few weeks. Both have reason to be optimistic they are on the right path. On the one hand, the bulls can point out that the stock has rebounded off the May 2023 lows for a 42% gain in the last three months. The stock has fallen by so much in the last two years that SMTC is due for an extended run. On the other hand, the bears can take solace in the fact that the stock seems to have resumed the decline that started in November 2021. SMTC is still facing a host of headwinds. However, only one can be right and one has to be wrong.

Bottom line, the time may have come to take some or all chips off the table for the next few weeks. The last few reports have triggered big moves in the stock, including a 21% drop in March, the first report after the Sierra acquisition. The next report could be a make-or-break moment for the stock. Whether it will turn out to be the former or the latter, some are likely to get burned if or when the stock moves against them. Moving to the sidelines removes this possibility.