Allegro MicroSystems Is Sending Conflicting Signals (NASDAQ:ALGM)

Allegro MicroSystems (NASDAQ:ALGM) got off to a bad start in 2022, but the stock has done much better in the second half of the year. ALGM seems to be on an uptrend, a reversal from earlier in the year when the stock was trending lower. In addition, the stock continues to get a lift from strong quarterly results, which have stayed resilient even though the semiconductor market is showing growing signs of weakness. However, there are also signs the stock is starting to waver, possibly opening the door for a new round of weakness. Why will be covered next.

The stock may be running out of steam

ALGM, a supplier of sensor and analog power ICs to the automotive and industrial markets, has seen the value of its stock drop in 2022, similar to other semis active in the semiconductor industry. However, the stock has been on the rise since it hit the low for the year in early July. The stock is still down 38% YTD, but all those losses can be attributed to the first half of the year as shown in the chart below.

Notice the change from the first half to the second half. The lower lows in the first half of the year have morphed into a series of higher lows in the second half of the year. The price action has gone from bearish to bullish. In the first half, the stock trended lower. In fact, the lower lows can be connected to form a descending trendline.

The recent highs can also be connected to form a horizontal trendline since they all topped out in the $26-27 region, suggesting this is where resistance lies beyond which the stock is likely to have trouble moving higher. The upper trendline remains to this day and has not changed in the second half of the year.

What has changed in the second half are the lows. They have gone from lower lows to higher lows. The lows can still be connected, but unlike the first half, the trendline for the lows in the second half is ascending. The charts could even be in the process of forming an ascending triangle with the lower trendline acting as support and the upper trendline acting as resistance. Such a chart pattern would strengthen the conviction of the bulls even more since it more often than not is resolved with a break through resistance on the way up.

However, it’s worth noting how the stock has been hugging the lower trendline in recent days, putting it in position to challenge and break through support. In fact, the stock stopped just short of the lower trendline on Monday, only to bounce before the stock could fall below it. There are two ways to look at this.

On the one hand, the fact that the stock has stayed above the trendline suggests support is standing its ground. The lows are still going higher. On the other hand, the fact that the stock is staying close to support and not making its way back up to challenge resistance is a cause for concern. If the stock keeps trying to break support, support could fail eventually. If support fails and the stock falls lower, the chart patterns could go from leaning bullish into something much less so. It would open the possibility that the downtrend from earlier in the year has not actually gone away.

There are other contradictions out there

Charts are not alone in sending conflicting signals. The same could be said of the semiconductor industry. On the one hand, the overall semiconductor market continues to expand in 2022. For instance, according to a recent report from WSTS, the semiconductor market is projected to grow by 13.9% YoY to a record $633B in 2022.

ALGM itself isn’t too shabby either. In fact, the company reached new record highs in its most recent earnings report. Q1 FY2023 revenue increased by 9% QoQ and 16% YoY to $217.8M, a new all-time high. Automotive contributed $149.6M. Non-GAAP EPS increased by 14% QoQ and 33% YoY to $0.24. Adjusted EBITDA was $66.7M in Q1 FY2023, up from $58.4M in Q4 FY2022 and $53.8M in Q1 FY2022. Cash and cash and equivalents reached $296M.

On the other hand, GAAP EPS fell to $0.05, which was mostly due to a 67% YoY increase in operating expenses, SG&A expenses in particular. The big increase in GAAP operating expenses is primarily due to $32.2M in stock-compensation expense in Q1 FY2023, up from $12.6M in Q4 FY2022 and just $3.6M in Q1 FY2022. Severance expenses worth $4.2M also had a negative impact on GAAP earnings. There was some share dilution with the number of shares outstanding on the increase. The table below shows the numbers for Q1 FY2023.

(GAAP)	Q1 FY2023	Q4 FY2022	Q1 FY2022	QoQ	YoY
Net sales	$217.753M	$200.293M	$188.142M	8.72%	15.74%
Gross margin	54.4%	54.7%	50.0%	(30bps)	440bps
Operating margin	6.9%	15.1%	17.1%	(820bps)	(1020bps)
Operating income	$14.737M	$30.249M	$32.242M	(51.28%)	(54.29%)
Net income	$10.283M	$25.652M	$27.707M	(59.91%)	(62.89%)
EPS	$0.05	$0.13	$0.14	(61.54%)	(64.29%)
(Non-GAAP)
Net sales	$217.753M	$200.293M	$188.142M	8.72%	15.74%
Gross margin	54.9%	55.6%	52.2%	(70bps)	270bps
Operating margin	25.3%	23.2%	22.3%	210bps	300bps
Operating income	$55.049M	$46.522M	$41.894M	18.33%	31.40%
Net income	$47.118M	$40.167M	$35.208M	17.31%	33.83%
EPS	$0.24	$0.21	$0.18	14.29%	33.33%

Click to enlarge

Source: ALGM Form 8-K

Guidance calls for Q2 FY2023 revenue of $220-230M, an increase of 16% YoY at the midpoint. The forecast expects non-GAAP EPS of $0.25-0.27, an increase of 30% YoY at the midpoint.

	Q2 FY2023 (guidance)	Q2 FY2022	YoY (at the midpoint)
Revenue	$220-230M	$193.6M	16.22%
Non-GAAP gross margin	54-55%	53.8%	70bps
Non-GAAP EPS	$0.25-0.27	$0.20	30.00%

Click to enlarge

In addition, ALGM raised its outlook for FY2023. Management had previously suggested at the start of the year that FY2023 revenue would grow in the high teens. The latest outlook raises that number to about 20%. Consensus estimates have since gone up and they now expect ALGM to end up with non-GAAP EPS of $1.05-1.08 and revenue of $910-927M in FY2023, up from $0.78 and $768.7M respectively in FY2022. From the Q1 earnings call:

“From a supply perspective, demand continues to exceed supply, with near-term tightness still largely related to 200-millimeter wafers availability. We continue to work closely with our manufacturing partners to ramp this supply. And as a result of our strong supplier relationships, we’ve been able to expand our available supply. With the incremental committed capacity, we are increasing our sales growth expectation for fiscal 2023 to approximately 20% over fiscal 2022.”

A transcript of the Q1 FY2023 earnings call can be found here.

There are still concerns out there

The industry and ALGM are both growing at a double-digit pace. The backlog is at record levels, suggesting no imminent decline is near. However, there are still concerns about the health of the semiconductor market. A growing number of high-profile semiconductor companies have reported weak earnings and/or forecasts. For instance, AMD (AMD) recently preannounced it would miss its guidance by a wide margin.

All these updates from industry heavyweights have cast a damper on all semiconductor stocks, ALGM included. It’s true not all semis are alike and some are active in different market segments than others. AMD, for instance, is more exposed to be PC market, whereas ALGM depends more on the automotive market. The latter appears to be holding up better than the former.

Nevertheless, there are persistent worries the weakness could spread to areas that are holding up like automotive. In theory, if consumers cut back on PC and smartphone buying, then the same could happen to automotive. Headwinds like a global recession affects everyone. A slowdown would be unwelcome since the stock looks expensive on a number of metrics. The table below shows some of the multiples ALGM trades at.

	ALGM
Market cap	$4.42B
Enterprise value	$4.17B
Revenue (“ttm”)	$798.3M
EBITDA	$175.7M
Trailing P/E	42.20
Forward P/E	30.37
PEG ratio	0.22
P/S	5.33
P/B	5.62
EV/sales	5.22
Trailing EV/EBITDA	23.72
Forward EV/EBITDA	14.08

Click to enlarge

Source: SeekingAlpha

For instance, ALGM trades at 30 times forward earnings with a trailing P/E of 42. The stock is valued at 5.6 times book value. Both may be too high in today’s volatile market where risk taking is not encouraged. ALGM is also a fairly young stock and does not have much of an established track record, especially in terms of growth. ALGM is doing okay at the moment, but it has yet to prove itself over the long run.

Investor takeaways

A previous article from July suggested that even though the stock was trending lower at that time, the stock was likely due for a reversal with the way the charts were laid out. This turned out to be the correct assessment since the stock has turned a downtrend in the first half of 2022 into an uptrend in the second half. However, while the current trend is leaning bullish, change may be underway.

There are a number of contradictions to deal with when it comes to ALGM. The company seems to be doing fine as the top and the bottom line are still growing at a double-digit clip. ALGM even raised its outlook recently. On the other hand, a growing number of semis are lowering their outlook due to weakening demand among end users, especially in the smartphone and PC market.

ALGM itself has yet to be impacted by the weakness others are seeing, but the market seems to be open to the possibility that it could give the price action this year. The stock has lost a big chunk of its value in 2022. The stock has recouped some of those losses in the second half, but the charts suggest the rally is running out of steam and may not be able to continue for much longer.

I am neutral on ALGM. Both the bulls and the bears could raise valid arguments concerning ALGM. The former could point to earnings growth and the latter could point to high valuations. The charts could be interpreted both ways. The uptrend in the second half remains with support standing its ground, but the stock could be close to breaking it. Automotive chip demand remains strong, but more and more companies are seeing declining demand for other types of chips.

Bottom line, it’s better not to pick sides when both parties raise valid arguments. Picking either side comes with risks. Things may change down the road, but at this point, not committing to either side makes the most sense. Only when one side gains a clear edge does it warrant a change in stance. Staying on hold is the way to go.