Monolithic Power Systems Stock: AI To Drive Resilience In Spite Of Choppy Market Backdrop

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Investment Thesis

Monolithic Power Systems (NASDAQ:MPWR) reported its fourth quarter of 2023 results and outlook this month. While revenue dropped 4% Y/Y this quarter due to the industry weakness and inventory correction cycle, MPS stock continued to outperform the peer group and S&P 500 on its higher enterprise data sales in 1HFY24, confirming its unique AI exposure. The stock is up 44% over the past six months versus the S&P 500, up 16%, and ON Semiconductor (ON), down 17%. The company’s above-consensus guidance for 1Q24 confirms my positive thesis that there is more upside surprise ahead in 1H24 driven by the company’s unique position in the AI market and partnership with Nvidia (NVDA).

I expect AI demand to continue outpacing supply in 1H24 and believe this will drive higher enterprise data sales for MPS sequentially and, by extension, drive stock outperformance. MPS is now guiding for sales to be in the range of $437 million to $457 million vs. consensus of $436.91 million – I take the above consensus guidance for next quarter as a positive sign for investors, confirming that while other markets may be feeling the weight of weaker industry end demand, MPS has a “get out of jail free” card which is its AI exposure. I recommend investors explore entry points to jump into the stock at current levels based on my belief that MPS is one of the better ways to play AI growth in the semi-space this year.

The following chart shows MPS stock against both the S&P 500 and On Semiconductor over the past six months.

MPS’ Value Proposition

MPS is a global semi-company that provides “high-performance, semiconductor-based power electronics solutions.” Essentially, the company operates in the power management industry, and under the current market backdrop, I firmly believe MPS will fare better than the peer group as it has the advantage of AI exposure to offset weaker end market demand, unlike other power/analog names, including On Semiconductor or Analog Devices (ADI). MPS provides power control modules that are used as parts in AI servers and data centers, so the increased demand for its power control modules comes from the ballooning demand for AI applications that continues to outpace supply.

My positive thesis has been reflected in the past two consecutive quarters: this quarter, the company achieved a 30% quarter-over-quarter growth in the segment, while last quarter, the company saw a 106% quarter-over-quarter growth. For the full year of 2023, management reported that enterprise data revenue increased by $71.6M to $323M, accounting for a 28.5% increase. MPS’ AI exposure lies in its partnership with Nvidia as a provider of power management solutions for NVDA H100 GPUs; last quarter, MPS stock traded higher on Nvidia’s beat and raised guidance. I believe MPS’ AI power solutions, particularly its 54V/48V in the accelerator module, shown in the image below, will support better-than-expect enterprise data results in 2024.

In my opinion, the company’s enterprise data segment is now its bread and butter, driving its outperformance and offsetting weakness from the industrial and auto-correction in 1H24 weighing on the analog and mixed-signal peer group. MPS has six core segments: storage & computing, enterprise data, auto, industrial, communications, and finally, consumer. In the second half of 2023, the company saw increased demand tailwinds in its enterprise data segment sales; I exemplify this in the following chart, in which you can see the company’s financial results by segment for the past three years. What should catch investors’ eye in this chart is how fast enterprise data sales grew in 2023 compared to their growth rate in 2022 and 2021.

Granted, MPS’ other market segments are seeing pretty choppy end demand, to say the least. Aside from the enterprise data segment, MPS’ other segments saw a year-over-year drop in sales for the most part. I don’t think this should rattle investors too much because the AI demand tailwinds should be enough to support outperformance for MPS into the next quarter. Enterprise data revenue increased 28.5% in full-year 2023, with management noting “higher sales of our power management solutions for AI applications.” Here’s an overview of the company’s segment results this quarter to help outline where MPS’ exposure lies.

Promising Auto Segment

I also see auto revenue growing at a healthier rate in the second half of the year due to the fact that auto is still in its early innings. There’s a long growth runway ahead, but the auto space is seeing a pullback at the moment due to the series of corrections taking place in the semi-industry that we’re seeing play out with Tesla (TSLA) and the broader EV peer group. Auto revenue is crucial for my longer-term, more positive outlook on MPS; the segment accounts for 21.7% of MTS’s full-year 2023 revenues, higher than 16.7% in 2022. I see more content gains could take MPS’ auto revenue to the higher double-digit range in the full year 2025. Michael Hsing, the company’s president and CEO, acknowledged this on the earnings call in the Q&A session, saying that “towards the end of the last year… auto slowed down. But overall, as Bernie said earlier, we still grow some high 20%, 30% somewhere in the overall — in the auto segment. These are mostly primary — mostly due to the ADS, the infotainment, or whatever the head units call it, the digital cockpit.”

I think IC and EVs felt the burn of the slowdown in the second half of 2023 and this year, but I see better auto revenue growth for MPS once the end demand recovers. I share the opinion of Rosenblatt Securities analyst Hans Mosesmann in his belief that MPS is well positioned to gain “from significant dollar content expansion in automotive platforms as the industry chases Tesla, Inc EV/autonomous driving innovation that prizes MPS programmable over-the-air power analog solutions.” The EV market is estimated to grow at a CAGR of 17.8% between 2023-2030, and so while MPS does face competition in the field, particularly from On Semiconductor, I believe there should be enough growth to go around once the auto market finishes its correction. For this year, I expect MPS to continue to outperform On Semiconductor due to its AI tailwinds and as the rest of the peer group is visibly weighed down by the weaker industry end demand and inventory correction cycle.

AI Justifies the Premium Valuation

Based on a relative methodology of valuing the stock, I believe MPS provides an attractive investment opportunity within its power and analog peer group. MPS is relatively expensive trading at a ratio of 16.9 EV/ C2024 Sales versus the peer group average of 10.3x, according to data from Refinitiv shown in the table below. I choose the EV/Sales ratio to value MPS as it sheds more light on the return MPS makes on its capital investments and the company’s value considering its financial performance minimizing the influence of the market’s overly optimistic or pessimistic sentiment at a given point in time which has become increasingly important with market noise around the AI boom moving stock prices. Investors shouldn’t shy away from the stock due to the higher valuation as MPS’ valuation matches the higher valuation nature of stocks with AI exposure; for the case of reference, Broadcom (AVGO), Marvell (MRVL), Advanced Micro Devices (AMD) and Nvidia all trade at a similar higher ratio than the peer group due to their potential AI exposure in 2024. On a P/E metric, the stock is also overvalued trading at 56.0x for CY2024 well above the peer group average ratio of 32.6. While MPS is trading at a premium valuation, I still see an attractive risk-reward profile for the stock due to its AI exposure in 2024.

In my opinion, MPS is more tied to Nvidia than the market is giving it credit for, so I can use Nvidia as an indicator for MPS and vice versa, at least for the near term. Wall Street also echoes my positive sentiment on the stock, with most analysts opting for a buy-rating even as the power and analog peer group suffer; the following is a chart made with data from Refinitiv that shows the street sentiment on MPS and how the stock price has reacted thus far.

What could go wrong?

No investment, as attractive as it is, can be 100% risk-free. MPS’ fourth quarter sales dropped year-over-year, and its non-GAAP gross margin was somewhat flat at 55.7%. I see a more favorable risk-reward scenario for MPS in 2024 as AI-related demand offsets industry-end demand weakness in other core segments and as other segments, specifically auto, are expected to rebound in 2H24. AI-related demand continues to outweigh supply in 1H24 but I don’t believe this will be the case forever; in fact, I think there is a significant amount of double-ordering in the AI supply chain as customers attempt to secure orders driven by concerns of long lead times and the supply shortage. I believe once supply catches up to demand, there will be a higher risk profile for MPS’ performance and I would then downgrade the stock to a sell. However, I don’t see this happening in 1H24 and that is why I emphasize the current investment window for MPS to ride the upward trend driven by AI while it lasts.

While MPS is at its core a power management semi-company, it is seriously building out with the Axign acquisition to penetrate the data converter market more seriously; I expect the company entering new markets on the single processing side will also drive growth in the mid-to-long run. I recommend investors buy the stock as I see EPS surprise ahead and believe the company will outpace both its peer group and Wall Street expectations.

What’s Next?

In my opinion, MPS is an under-the-radar AI pick that hasn’t been overbought or overplayed yet; the stock hasn’t priced in its full AI upside. I recommend investors pay more attention to the stock and explore entry points on pullbacks. The stock is overvalued, trading above the peer group on both the EV/Sales and P/E metrics but I believe the higher valuation is justified as long as the stock remains an AI play. I believe there is still more upside before AI lets out. I would consider abandoning the stock when AI supply meets demand in which case I expect the wave of double-ordering will cripple the AI run-up and negatively impact names like MPS. I look to Nvidia’s outlook as a guide to gauge the current and near-term supply-demand dynamic and given management’s above consensus outlook this quarter, I see more room for upside for MPS based on AI tailwinds. I see the stock trading higher in 1H24 from a fundamental standpoint due to the company’s AI roadmap and offerings.