Allegro MicroSystems: A Rising Star in the Auto Industry

Wall Street appears to have mixed feelings about Allegro MicroSystems, an up-and-coming chip maker based in New England. The company has experienced a rapid increase in sales to the auto industry, propelling its stock price to impressive heights. While Allegro stock surged by 150% and reached a peak above $50 in July, it has subsequently eased back to around $38. Nevertheless, even with the recent retreat, Allegro's stock is still valued at 37 times its operating earnings, which is approximately twice the multiple of the S&P 500.

Interestingly, all but one of the half-dozen brokerage firms covering Allegro MicroSystems rate the stock as a Buy. These analysts argue that Allegro's dominance in magnetic sensor chips will continue to drive the stock price upward by an estimated 45%. Despite this bullish sentiment, some buyside investors remain unconvinced that Allegro's growth and exceptional profit margins are sustainable. In fact, they have taken short positions on approximately 8% of Allegro's float, betting on a future decline in stock price.

Allegro MicroSystems went public at $14 in a spinoff from Japan's Sanken Electric in late 2020. Since then, the company's sales have skyrocketed, increasing from $590 million in the fiscal year ended March 2021 to an impressive $975 million in the March 2023 fiscal year. Over the same period, earnings per share rose from 50 cents to $1.28 as chips like Allegro's experienced high demand. These chips are sought after for their use in vehicles with assisted-driving features or electric power.

According to Chief Financial Officer Derek D'Antilio, Allegro's specialization in magnetic sensors and a few power applications has allowed the company to establish a defensible niche in the market. By dedicating their time to innovation in these areas, Allegro has cultivated a competitive advantage.

Following the spinout from Sanken Electric, Allegro's gross margins experienced a significant boost, escalating from 40% in fiscal year 2020 to an impressive 56% in 2023. One contributing factor to this margin expansion was Allegro's transition to a "fabless" approach, relinquishing control of its Minnesota fabrication plant Polar Semiconductor to Sanken.

Allegro's current gross margins of 56% far exceed those of comparable competitors, such as Melexis, a Belgian firm specializing in magnetic sensors for autos. Melexis' gross margins stand at 45%.

In conclusion, Allegro MicroSystems has firmly established itself as a rising star in the auto industry. With its impressive sales growth, exceptional profit margins, and specialization in magnetic sensors, Allegro is well-positioned for future success. As investors weigh the stock's potential, diverse opinions abound. Only time will tell if Allegro can maintain its upward trajectory or if skeptics will prove their doubts well-founded.

Allegro's Unusual Margins Raise Questions

Allegro, a leading semiconductor company, has come under scrutiny due to its unusual profit margins and its dealings with related parties, Sanken and Polar. Sanken currently owns a majority stake of 51% in Allegro, which is valued at an impressive $3.8 billion, twice Sanken's own market cap. Additionally, One Equity Partners, a private-equity firm that was previously JPMorgan Chase's buyout arm, owns 9% of Allegro.

An analysis of Allegro's sales reveals that around 17% of its total revenue comes from Sanken. Moreover, Allegro relies on Polar, a company owned 70% by Sanken and 30% by itself, for a third of its semiconductor wafers. Although One Equity agreed to invest in the Polar plant, resulting in a majority stake, the deal has yet to be finalized. It is worth mentioning that Polar has been facing financial difficulties, having borrowed $15 million from Allegro in the past two years.

These circumstances have raised suspicion among hedge fund analysts who speculate that Polar may be charging Allegro below market value, effectively subsidizing Allegro's exceptional profit margins. They also question whether these high-profit margins can be sustained once Sanken reduces its stakes in Allegro and Polar.

To address these concerns, we reached out to D'Antilio, Allegro's CFO. According to him, the gross margins are indeed real and are independently achieved. He emphasized that Allegro's audit committee ensures that all transactions with related parties adhere to fair market prices.

D'Antilio also clarified that aside from Polar, Allegro works with two other wafer suppliers, United Microelectronics (UMC) and Taiwan Semiconductor Manufacturing (TSM), both based in Taiwan. The pricing from Polar lies somewhere between that of UMC and TSM.

Furthermore, the market for advanced driver assistance systems in cars appears to have reached its saturation point, with most vehicles already equipped with collision avoidance and adaptive cruise control features.

However, Allegro has warned that its recent surge in sales to the auto industry might slow down in the coming quarters. This is due to auto manufacturers working through their chip inventories and a temporary lull in China's large market.

Given these uncertainties, investors may want to exercise caution until there is greater visibility into Allegro's business performance.