Silicon Motion Technology Stock: Favorable Risk-Reward (NASDAQ:SIMO)

Silicon Motion Technology Corporation (NASDAQ:SIMO) is off to a bad start in 2022. The stock has lost a quarter of its value YTD in what has been a fairly steady downtrend. However, the stock is now in a position to put an end to this downtrend with factors like valuations, charts and fundamentals in its favor. Why will be covered next.

The stock is facing resistance

SIMO had a terrific year in 2021 with the stock gaining 97%, but 2022 has been something else with the stock losing 25% YTD. The stock ended 2021 on a high note with a gain of 38% in the month of December, thanks in part to a new $200M stock buyback program announced on December 7, which pushed the stock up 16% on that day. However, it's been downhill ever since. The chart below shows how the stock's fortunes flipped with the ringing of the new year.

The stock hit its low of the year on March 14 after a fairly steady downtrend, followed by a strong rebound that saw the stock gain a quick 9% in the days after. The bounce is interesting because it happened at around $65, which also happens to be a price level where the stock encountered lots of resistance in the past.

It took quite a bit of effort before the stock was able to get past this resistance after multiple failed attempts. In fact, the stock was only able to do so on July 30, which also happens to be the day the stock soared higher by 17% thanks to the Q2 FY2021 earnings report. An earlier article delves into greater detail as to why the stock reacted as well as it did to the Q2 report.

What used to be resistance tends to become support, which appears to be what happened in recent days. The stock seems to have found support where resistance used to be. On the other hand, the stock is still in the downtrend that has been in effect for all of 2022. The stock is still being contained by the trendline formed by a series of lower highs. If it is to end this downtrend, the stock will have to break through what appears to be resistance on the way up.

The stock has some things in its favor to help it power through resistance

The stock is wedged between support and resistance. If the former stands its ground and the latter gives way, the stock could go up. Alternative, the stock could go down if the opposite happens. Both have yet to yield, which means SIMO may need a catalyst to break the deadlock. For instance, SIMO may need to lure buyers by convincing them that it is time to get in on the stock, pushing it upwards. Valuations could be important. If a stock is deemed expensive, the stock may have trouble attracting buyers, forcing the stock to lower its asking price.

The table below shows the multiples SIMO trades at. Multiples are much lower in comparison to the 5-year average or to the sector median, with the exception of price-to-book that is more in line with the average. For instance, SIMO has an enterprise value of $2B, which is about 7.6 times EBITDA on a trailing basis and 5.7 times EBITDA on a forward basis.

Source: Seeking Alpha

Earnings growth could be more of a question mark

Earnings are another potential catalyst. After all, the Q2 report was able to power the stock through resistance before, so it could always happen again. It's therefore worth noting that the stock did not react well to the Q4 report, falling 8% in response, even though SIMO reported record numbers. The table below shows the numbers for Q4 FY2021.

Q4 revenue, for instance, increased by 83.7% YoY to a record $264.4M, which is also the fifth consecutive sequential quarterly increase. GAAP EPADS increased by 4225% YoY to $1.73 and non-GAAP EPADS increased by 120.9% YoY to $1.90. Gross margins declined slightly QoQ, but non-GAAP operating margin was 30.9%, a new all-time high.

Note that there was an impairment charge of $17.49M in Q4 FY2020, which affected the GAAP numbers in that quarter, skewing the YoY comparisons. The charge is not included in the non-GAAP numbers, which accounts for most of the difference between the GAAP and non-GAAP numbers. The former also includes $8.99M in stock-based compensation, but the latter does not.

Source: SIMO Form 6-K

If the Q4 numbers are available, then so too are the numbers for the whole year. FY2021 revenue increased by 70.9% YoY to $922.1M, blowing past the old high set in FY2020. GAAP EPADS increased by 150.4% YoY to $5.71 and non-GAAP EPADS increased by 91.7% YoY to $6.21.

The FY2021 numbers were impressive, but guidance was something else. In fact, Q1 guidance could be labeled soft, which helps explain why the stock did not react well, even with record numbers from SIMO. Guidance calls for Q1 FY2022 revenue of $225-238M, an increase of 12.7% YoY at the midpoint.

Not only is it much less than previous quarters, but it's also a decline of 12.4% QoQ. SIMO's streak of sequential increases in quarterly revenue will therefore end at five, the last four being record highs. Q1 FY2022 will not be one unlike its predecessors. The outlook does see growth picking up after Q1 with the forecast calling for FY2022 revenue of $1,110-1,200M, an increase of 25.3% YoY at the midpoint. Still, that's much less than FY2021's growth of 70.9%.

It's worth reminding that SIMO is still limited by capacity constraints, which put a hard cap on its ability to meet market demand and therefore its ability to grow. SIMO has been allocated additional supply, but only enough to sustain a growth rate of 20-30% in 2022. From the Q4 earnings call:

"For full year 2022, we have again received meaningful incremental wafer supply from our primary foundry partner. Based on this incremental wafer supply, we will be able to grow full year sales 20% to 30%. We believe, however, that there are opportunities for us to grow even faster than this baseline range."

A transcript of the Q4 FY2021 earnings call can be found here.

However, while some may be disappointed by the slower growth rate, it's important not to attach too much weight to full-year guidance at this point. Recall how SIMO guided for FY2021 revenue growth of 20-30% a year ago, which turned out to be more like 70.9% when all was said and done. SIMO has a range of options available with which it can drive sales and profit growth, even in the presence of supply constraints. For instance, product mix optimization and price adjustments are possible avenues worth exploring. FY2022 guidance could prove to be too conservative.

Investor takeaways

The year 2021 was a year to remember for SIMO. Each of the four quarters turned in a record-setting performance. Both revenue and earnings reached record highs. The stock also turned in a record-setting performance, reaching heights not seen before. All this happened with SIMO still shackled by supply constraints, which limit its ability to meet demand and hence its ability to grow.

However, 2022 has turned out to be quite the difference. The stock has lost a quarter of its value, weighed down by a number of factors. Like other tech stocks, SIMO has been affected by market shifts triggered by the Federal Reserve. The Fed unleashed unprecedented amounts of liquidity, which has found its way to stocks, tech in particular.

But the Fed wants to tighten, in effect transforming itself from a tailwind to a headwind for stocks. The conflict in Europe only made things worse for SIMO by setting off more market turmoil. The stock went down in a channel. It bounced off of support, but it has yet to break resistance. The downtrend remains intact with both support and resistance in play.

It's not easy sticking with SIMO with all of this going on, but I am bullish on SIMO nevertheless. It's true the factors that have weighed on the stock remain out there. There's lots of uncertainty out there, especially as it relates to geopolitical tensions and the Fed's policy towards inflation, which leads to heightened volatility, making it risky to make big bets on stocks.

On the other hand, the stock is hovering above what should be a major support level. It took a lot of effort to break through this level when it served as resistance, which suggests it won't be easy for the stock to fall below it now that it has become support. The stock should also have a backstop with multiples where they are.

Long-term prospects for NAND and their controllers are as strong as ever. While guidance may not be as strong as what some hoped for, the forecast still sees double-digit sales and profit growth. There's also a real chance that the forecast will prove to be too pessimistic as it was last year. There is simply a lot more to like in SIMO than not to like. If anyone is in it for the long haul, then long SIMO is the way to go.

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