Silicon Laboratories Q4 Preview: Why The Stock Could Be Heading Lower (NASDAQ:SLAB)

Silicon Laboratories (NASDAQ:SLAB) has staged a powerful rally in the last three months or so and by doing so has recouped a portion of the losses suffered during the slide in the preceding nine months. This slide in the stock culminated in a disastrous quarterly guidance in early November, which, for instance, called for revenue to drop by two-thirds YoY, mostly due to excess inventories on top of already weak industry demand. However, the stock could be getting ready for another reversal, similar to the recent past, especially with SLAB set to release its next report on January 31. Why will be covered next.

Why the recent rally may have only been corrective in nature

A previous article from from July 2023 rated SLAB a hold after concluding that even though the stock was in the midst of a rally, the upcoming report was likely to shake things up for SLAB. The article noted how the stock had exhibited great volatility after prior earnings reports, which were often followed by major selloffs.

In addition, there was reason to believe SLAB could face a further weakening of demand based on what other companies had reported about the state of the industry, even though SLAB was already dealing with faltering demand. Weak demand would inevitably affect growth, which is a problem for a stock like SLAB that trades at a premium with multiples far higher than most in the sector.

The chart above shows why the article conclusions were warranted with the way the stock proceeded to collapse after the July report. The stock did not stop falling until it hit a 52-weeks low of $74.56 on November 1 following the Q3 FY2023 report. To put this in perspective, the stock closed at $158.72 before the July report. However, the stock staged a powerful rally afterwards, which led to the stock closing at $128.43 on January 26.

Yet notice how the stock has struggled getting past the $130-140 region. The stock turned south after hitting the aforementioned region in December and it happened again in the last few days. This is unlikely to be a coincidence. It’s therefore worth mentioning that the reason is very likely because the $130-140 region is where resistance could be lurking, which would give sellers a reason for wanting to pull the trigger in this region.

Recall how the stock fell from the February 2023 high of $194.68 to the November 2023 low of $74.56. The 50% Fibonacci retracement of this downtrend is $134.62, which is halfway through the $130-140 region. This suggests the stock has encountered resistance in the $130-140 region. It also suggests the stock has yet to truly bottom and the recent rally off the November lows was just corrective in nature.

Why the stock sold off to rally afterwards

It’s no coincidence the stock hit a 52-weeks low on November 1 because that is when SLAB released its most recent report. SLAB actually surpassed estimates for the top and the bottom line, if only slightly. Still, Q3 FY2023 revenue declined by 16.8% QoQ and 23.5% YoY to $203.8M and non-GAAP EPS declined by 40.4% QoQ and 48.8% YoY to $0.62.

Note how the number of shares decreased due to stock buybacks, which is why cash, cash equivalents and short-term investments fell to $417.1M, partially offset by a $45M revolving line of credit on the balance sheet. This is down from $1,191.9M a year ago. The table below shows the numbers for Q3 FY2023.

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Source: SLAB Form 8-K

However, it was guidance that stole the spotlight. The consensus expected SLAB to call for revenue of $207M, but Q4 FY2024 guidance calls for revenue of $70-100M, a decline of 66.9% YoY at the midpoint, much worse than expected. The forecast also calls for a GAAP loss of $1.95-2.39 per share and a non-GAAP loss of $1.22-1.66 per share.

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Guidance was quite the shocker, which is why management had to add some color. SLAB is dealing with excess inventories. From the Q3 earnings call:

“Current market environment continues to be characterized by a difficult combination of weak demand and high inventory. Specifically, end customers carry to — continue to carry inventory levels that are too high. At the same time, our end customers’ demand environment continues to be weaker than previously forecast.

In particular, we see weakness extending further into the broad industrial end market. As a result of these factors, our fourth quarter will be negatively impacted across both business units.”

A transcript of the Q3 FY2023 earnings call can be found here.

When will the inventory problem be resolved?

The stock fell as much as 19.1% on November 1, but the stock recovered to end the day down 5.4%. There were several factors that limited the fallout. This included a rating upgrade from Barclays the same day. Furthermore, the earnings call suggested the bottom would be in Q4, followed by sequential growth.

“Based on everything we’re seeing, we believe Q4 will be our bottom, and we expect to return to sequential growth in the first quarter of 2024.”

Further comments suggested a quarter of excess inventories or about $200M. Most of it is expected to be consumed in Q4.

“It’s unclear how much more of a correction Industrial has as an end segment. So, there’s some headwinds there. And on end customer inventory, that would be awesome if it was super clean on the quarter boundary, but it isn’t. It’s not uniforms across our customers. We talk to — as I said, our top 40 or 50, they’re carrying more than they should, some less, some more, some extending into Q1 and Q2, some okay now.

But if you average it all out, it’s really the biggest impact is, it’s about a quarter that they have. They’re carrying more than they typically should or would. So that’s important. So, we’re not saying the inventory headwind will go away, but the biggest piece of it should hopefully be addressed.”

If Q4 FY2023 revenue comes in at the midpoint or $85M, and if it would have been $200M if there was no inventory problem, then this suggests the following quarter or Q1 FY2024 will be left with excess inventories of $85M. This suggests guidance in the upcoming report will call for Q1 FY2024 revenue of around $115M, a QoQ increase of $30M. SLAB is almost certain to guide for another loss in the upcoming report with such revenue, although a smaller one than Q4’s $1.44 with an estimated loss of around $1.00.

What is SLAB’s true quarterly run rate?

The inventory problem could be over as soon as Q2 FY2024. However, the inventory issue could have more legs to it. If inventories build up, then this implies real demand was less in previous quarters. Keep in mind that quarterly revenue grew strongly in recent quarters. For instance, the quarterly run rate peaked at about $260M in Q1 FY2023. The question than becomes what the run rate would have been like if it was based on just real demand.

It’s possible SLAB benefited from distortions caused by the COVID-19 pandemic and the resulting stimulus that followed. This could have raised demand for all things, including products from SLAB. If this is correct, then the real quarterly run rate may be closer to what it was prior to COVID-19, although probably higher since it is unlikely there was no increase in real demand, especially when it comes to IoT.

SLAB’s revenue in Q4 FY2019, the last quarter prior to COVID-19 was $128M, excluding the contributions from divested assets. If we apply a 10% annual growth rate, then this results in a quarterly run rate of about $185M by FY2023. This is below the $238M run rate SLAB has reported for the last four quarters.

What will FY2024 be like for SLAB?

SLAB is projected to end up with non-GAAP EPS of $1.34 on revenue of $780.4M in FY2023, assuming Q4 ends up with a loss of $1.44 per share. This gives SLAB a trailing non-GAAP P/E ratio of 95.8 with the stock priced at $128.43. FY2024 revenue is estimated to come in at about $670M with Q1 revenue of $115M and a run rate of $185M per quarter the rest of the way.

Non-GAAP EPS will drop accordingly to an estimated $0.85, weighed down by Q1’s projected loss. This would give SLAB a forward non-GAAP P/E ratio of 151 with a stock price of $128.43. These multiples are definitely on the high side. They may go even higher if the inventory problem lasts longer than expected and/or demand weakens further.

Investor takeaways

SLAB is scheduled to release its Q4 FY2023 report on January 31. Guidance is very likely to call for another loss, but the numbers should present a major improvement over the preceding quarter. The real issue to be addressed is what comes next. Specifically, what is real demand really like at SLAB. SLAB may have comments at to the outlook for FY2024 and this may determine the market reaction.

With the inventory issue SLAB has implicitly acknowledged real demand was less than reported in past quarters. Quarterly revenue run rate currently stands at $238M, but if not for customers ordering more than they really needed, which caused the excess inventory problem, the actual run rate could very well have been lower. The big question is how much lower.

The stock has rallied and gained as much as 72.2% off the November low. With this rally in the backdrop and with the Q4 report due in a few days, it would be prudent to take a step back and reduce exposure to SLAB. There is the possibility SLAB could disappoint with its outlook for FY2024, whether it is due to the inventory issue proving to be stickier than anticipated or because bookings are not recovering the way SLAB thought it would.

Weak growth is major problem for a stock like SLAB because it is by no means a cheap stock. On the contrary, SLAB trades at high valuations with commonly referenced multiples in the triple digits. Such a high multiple is warranted when the company grows at a pace proportional to it, but not when there is little to no growth to be had.

The charts leave open the possibility the decline that started early last year is not yet over. The rally since November may have been corrective in nature after the big drop in the stock. There is reason to believe the stock has encountered resistance. If the stock wants to move lower, there is certainly room for it to do so.

Keep in mind that SLAB earnings reports have a history of serving as a catalyst for major moves in the stock, including the most recent one to be released. The reports have on multiple occasions triggered major reversals in the stock. Not only to the upside, but also to the downside. The upcoming report could very well do the same, especially with the outlook clouded by uncertainty. It is definitely time to proceed with caution at this point.

I am neutral on SLAB with all the above in mind. The stock has come a long way in a short amount of time, but the upcoming report has the potential to send the stock lower. The trend for the last 12 months is pointing down, temporary rallies notwithstanding. Multiples are high for a stock that is dealing with weak demand. Put all this together and you have a lot of incentive to not wager and risk suffering a loss.