Allegro MicroSystems: Setting Itself Up For A Reversal (NASDAQ:ALGM)

Allegro MicroSystems (NASDAQ:ALGM) has been sliding ever since the year started. ALGM continues to reach new highs in terms of the top and the bottom line and guidance expects more of the same, but that has not been of much help since the stock reached new lows in July. However, there are indications things are looking up for ALGM. Why will be covered next.

ALGM could be going for a reversal

ALGM has found it tough going this year, having lost 37% of its value YTD. Moreover, the stock has trended lower all year with the lows and highs going down. In fact, the lows and the highs can be connected to form trendlines that are pointing down. The stock did make several attempts at a comeback, only to have all of them fizzle out. The chart below shows how the stock has racked up losses in 2022.

However, the chart also shows how the stock is once again making another attempt at a comeback in recent days. There’s reason to believe the stock could succeed this time around. The stock has gained more than 15% in recent days. In doing so, the stock has overtaken the 20-day moving average and the 50-day moving average, a bullish signal.

Note how the stock stopped just short of breaking through the upper trendline connecting all the recent highs. This trendline has served as resistance all throughout the year, pushing the stock lower due to it sloping downwards. The fact that the stock closed just at the edge is a sign resistance is present. What happens next will be interesting. The stock can either break through or, alternatively, resistance could prevail and the stock could be heading downwards.

The stock is not there yet, but breaking the trend by closing above the trendline would be another positive signal for the bulls, especially if it is accompanied by heavy volume. In addition, while there are no guarantees and resistance may succeed in holding its ground, there is some reason to think a breakthrough is likely.

It’s worth mentioning that the charts have painted what could be described as a falling wedge pattern, which is generally considered a bullish reversal pattern. In a falling wedge, the stock moves lower between two descending trendlines. The slope of the upper trendline is somewhat steeper than the lower trendline, which results in the two trendlines converging on one another.

The stock can break through either the upper or lower trendline, but, more often than not, the stock tends to break in the opposite direction of the trendlines in a falling wedge. Both of the trendlines are pointing down, which suggests a move up through the upper trendline is more likely than a move down below the lower trendline.

The odds are in favor of a move higher, possibly to the $25 region where it is likely to encounter another resistance level. Remember how the stock spent months going sideways between $25 and $30 earlier in the year. The stock fell below this trading channel, but the stock may be trying to get back there. The stock still needs to overcome resistance, but as it stands right now, the stock looks poised to complete a reversal of the existing downtrend.

The fundamentals are still in good shape at ALGM

The charts have leaned bearish for much of 2022, but they seem to be in the process of shifting towards a more bullish stance. Such a shift would be made easier if accompanied by other supporting factors, like improving fundamentals. A look at the most recent earnings report shows that the fundamentals remain solid. If anything, there is reason to believe they are likely to get better.

For instance, Q4 revenue increased by 14.4% YoY to $200.3M, a new record high. GAAP EPS increased by 160% YoY to $0.13 and non-GAAP EPS increased by 40% YoY to $0.21. Note that the sequential decline in Q4 GAAP earnings was mostly due to a doubling in stock-compensation expense with the fiscal coming to an end. Non-GAAP gross margin reached a record 55.6%. The table below shows the numbers for Q4 FY2022.

(GAAP)	Q4 FY2022	Q3 FY2022	Q4 FY2021	QoQ	YoY
Net sales	$200.293M	$186.629M	$175.108M	7.32%	14.38%
Gross margin	54.7%	54.2%	49.7%	50bps	500bps
Operating margin	15.1%	19.1%	11.1%	(400bps)	400bps
Operating income	$30.249M	$35.605M	$19.448M	(15.04%)	55.54%
Net income (loss)	$25.652M	$32.973M	$8.689M	(22.20%)	195.22%
EPS	$0.13	$0.17	$0.05	(23.53%)	160.00%
(Non-GAAP)
Net sales	$200.293M	$186.629M	$175.108M	7.32%	14.38%
Gross margin	55.6%	54.8%	50.9%	80bps	470bps
Operating margin	23.2%	23.1%	19.7%	10bps	350bps
Operating income	$46.522M	$43.091M	$34.438M	7.96%	35.09%
Net income (loss)	$40.167M	$36.091M	$28.440M	11.29%	41.23%
EPS	$0.21	$0.19	$0.15	10.53%	40.00%

Source: ALGM Form 8-K

Q4 capped off what was a record-setting year in FY2022. FY2022 revenue increased by 30% YoY to $768.7M. Automotive accounted for 69% of revenue. GAAP EPS increased by 520% YoY to $0.62 and non-GAAP EPS increased by 69.6% YoY to $0.78. ALGM ended FY2022 with $290M in cash and equivalent, partially offset by $25M in long-term debt. On the other hand, there was share dilution. The number of weighted-average shares outstanding rose from 176.4M to 191.8M YoY.

(GAAP)	FY2022	FY2021	YoY
Net sales	$768.674M	$591.207M	30.02%
Gross margin	53.0%	47.2%	580bps
Operating margin	17.8%	2.0%	1580bps
Operating income	$136.650M	$12.158M	1023.95%
Net income (loss)	$119.555M	$18.101M	560.49%
EPS	$0.62	$0.10	520.00%
(Non-GAAP)
Net sales	$768.674M	$591.207M	30.02%
Gross margin	54.1%	50.0%	410bps
Operating margin	23.2%	16.4%	680bps
Operating income (loss)	$178.156M	$96.683M	84.27%
Net income (loss)	$150.136M	$81.850M	83.43%
EPS	$0.78	$0.46	69.57%

Source: ALGM Form 10-K

Guidance calls for Q1 FY2023 revenue of $205-210M, an increase of 3.6% QoQ and 10.3% YoY at the midpoint. The forecast sees non-GAAP EPS of $0.22-0.23, an increase of $0.01-0.02 QoQ and $0.04-0.05 YoY. From the Q4 earnings call:

“Now turning to our Q1 outlook. We expect sales to be in the range of $205 million to $210 million. We expect automotive and industrial to be up low-single digits sequentially, while other will be flat. We expect non-GAAP gross margin to be in the range of 54% to 55%. We anticipate non-GAAP earnings per share will be in the range of $0.22 to $0.23.”

A transcript of the Q4 FY2022 earnings call can be found here.

More importantly, ALGM expects growth to accelerate as FY2023 progresses. As mentioned in a previous article, ALGM was and continues to be supply constrained due to foundries running at max capacity, slowing down growth. However, ALGM has been trying to secure additional capacity from its foundry partners and it appears those efforts are bearing fruit, clearing the way for additional supplies and increased sales by extension.

“With a strong alignment to these secular growth trends, large and expanding SAM, design win momentum and record levels and growing backlog, we’re off to a great start in fiscal 2023. We continue to navigate through the supply demand imbalance, and we are raising our full-year revenue growth outlook to the high-teens.”

The outlook sees ALGM growing in the low teens in Q1, but this is expected to ramp up into the high teens by the time FY2023 is over. The consensus estimate is for ALGM to finish FY2023 with a non-GAAP EPS of $0.92-1.08, a YoY increase of 17.9-38.5%.

Valuations may be a stumbling block for some

ALGM is making progress on several fronts, but some might still not be totally convinced when it comes to ALGM. One possible reason has to do with valuations. ALGM does not trade at lofty valuations, but one could make an argument that there is room for valuations to go down. For instance, the stock is valued at 5.67 times book value, which may be too high for some. The median is around 3.14. The table below shows the multiples for ALGM.

	ALGM
Market cap	$4.19B
Enterprise value	$3.94B
Revenue (“ttm”)	$768.7M
EBITDA	$191.8M
Trailing P/E	35.42
Forward P/E	26.07
PEG ratio	0.07
P/S	5.42
P/B	5.67
EV/sales	5.12
Trailing EV/EBITDA	20.53
Forward EV/EBITDA	14.85

Source: SeekingAlpha

Investor takeaways

Sentiment towards companies in the semiconductor space has worsened in 2022 as there have been increasing reports of falling demand for such consumer items like PCs and smartphones, both big users of semiconductor chips. The concern is that this falling demand from end-users will find its way back to suppliers of semiconductor chips, resulting in earnings getting worse.

However, it appears that demand for certain types of semiconductor chips is holding up better than others, at least at this point. Automotive chips, for instance, are one example. It just so happens that ALGM is primarily a supplier of automotive chips, including to electrical vehicles. The latest quarterly numbers show that ALGM is doing fine, even though ALGM continues to face supply constraints which limit its ability to grow and meet all the demand out there.

Furthermore, ALGM has been able to secure more capacity from foundries, which opens the door for a pickup in growth. Growth in recent quarters has been hampered by a lack of sufficient supplies, but that stands to improve as more supplies become available in the coming year. ALGM completed a record-setting year in FY2022 and FY2023 looks set to be another record-setting year with the backlog at record levels.

The stock has languished all year, but it is now in a position to change course if the charts are any indication. While the stock has yet to break through resistance, it looks poised to do so based on current chart patterns. The stock may need some time before it finally manages to break through and it is possible the stock could fail to overcome resistance, but the stock is more likely to be heading up than down with the way the cards are laid out at the moment.

It’s tempting to go long ALGM, but I remain neutral on ALGM nevertheless. While automotive chip demand has held up better than other types of chips, it’s possible the slowdown in chip demand could spread, including to automotive. Some carmakers have mentioned noticing an easing in the current shortage of automotive chips. This is likely to continue with lots of new fab capacity coming online in the coming years. ALGM may find the market to be less favorable as the quarters go by.

While the asking price has dropped significantly this year, it’s still not low enough to please everyone, especially not at a time when many other semis are available at multiples that one could argue are more appealing. If multiples go down even more, another evaluation is warranted. As it stands, ALGM is a hold.