This Specialty Chip Stock Has Strong Earnings and Fat Margins. That Stirred Suspicions.

All but one of the half dozen brokerage firms covering the stock (ticker: ALGM) rate it a Buy, arguing that Allegro’s lead in magnetic sensor chips will lift the stock by 45%. But a number of buyside investors aren’t convinced Allegro’s growth and exceptional profit margins can last. They’ve joined the 8% of Allegro’s float that’s short, in a bet that the stock will drop.

The company came public at $14, in a late 2020 spinoff from Japan’s
Sanken Electric
(6707.Japan). Allegro sales have jumped since—from $590 million in the fiscal year ended March 2021, to $975 million in the March 2023 year. Earnings rose over the same interval, from 50 cents to $1.28 a share. That’s because chips like Allegro’s have been in demand as more cars include assisted-driving features, or run on electric power.

Specialization gives Allegro a defensible niche, says Chief Financial Officer Derek D’Antilio. “We spend all of our time focusing on innovation in magnetic sensors and a few power applications,” he says.

With its spinout from Sanken, Allegro’s gross margins swelled— from 40% in fiscal 2020, to 56% in 2023. Part of that margin expansion came from Allegro’s going “fabless,” as it left its Minnesota fabrication plant Polar Semiconductor in Sanken’s control.

Allegro’s 56% gross margins now far exceed those of comparable competitors, such as
Melexis
(MELE.Belgium), a fabless Belgian firm that also sells magnetic sensors for autos. Melexis’ gross margins are 45%.

Allegro’s unusual margins spurred some investment fund analysts to scrutinize its dealings with its related parties, Sanken and Polar. At the end of the March 2023 year, Sanken owned 51% of Allegro stock—currently worth $3.8 billion (twice Sanken’s own market cap). Another 9% was owned by One Equity Partners, the private-equity firm that was once the buyout arm of JPMorgan Chase. About 17% of Allegro’s sales went to Sanken for the year ended in March 2023.

Allegro gets a third of its semiconductor wafers from Polar, which is 70% owned by Sanken and 30% by Allegro. Early this year, One Equity agreed to put money into the Polar plant in exchange for a majority stake, but that deal hasn’t closed. The financial statements of Sanken and Allegro indicate that Polar has been unprofitable, and that it has borrowed $15 million from Allegro over the last two years.

That makes some hedge fund analysts wonder if Polar is undercharging Allegro and thereby subsidizing Allegro’s exceptional profit margins. They also wonder if the chip vendor’s margins will persist, as Sanken reduces its stakes in Allegro and Polar.

We asked D’Antilio about those concerns. “The gross margins are real,” he says. “Our P&L is a completely independent P&L.” The audit committee of Allegro’s board ensures that all related-party transactions are arms-length, says the CFO.

He notes that Allegro has two other wafer suppliers—the Taiwanese producers
United Microelectronics
(UMC) and
Taiwan Semiconductor Manufacturing
(TSM). Polar’s pricing to Allegro falls in between that of UMC and TSM, says D’Antilio.

Meanwhile, the penetration of advanced driver assistance systems in cars seems nearly complete, with most now featuring collision avoidance and adaptive cruise control.

Allegro has cautioned that its recent burst of sales to the auto industry may slow over the next few quarters, as auto makers work through chip inventories and sales pause in China’s large market.

Investors may want to tap the brakes, too, until visibility into Allegro’s business improves. Bill Alpert

Write to Bill Alpert at [email protected]