Magnachip has been treading water for the past six months, recording a small return of 3.9% while holding steady at $4.25.

Is there a buying opportunity in Magnachip, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.

Why Do We Think Magnachip Will Underperform?

We're swiping left on Magnachip for now. Here are three reasons why you should be careful with MX and a stock we'd rather own.

1. Revenue Spiraling Downwards

A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Magnachip struggled to consistently generate demand over the last five years as its sales dropped at a 18.5% annual rate. This was below our standards and signals it’s a low quality business. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions.

2. Low Gross Margin Reveals Weak Structural Profitability

In the semiconductor industry, a company’s gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor.

Magnachip’s gross margin is one of the worst in the semiconductor industry, signaling it operates in a competitive market and lacks pricing power. As you can see below, it averaged a 19.3% gross margin over the last two years. That means Magnachip paid its suppliers a lot of money ($80.72 for every $100 in revenue) to run its business.

3. Cash Burn Ignites Concerns

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Magnachip’s demanding reinvestments have drained its resources over the last two years, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 9.3%, meaning it lit $9.33 of cash on fire for every $100 in revenue.

Final Judgment

Magnachip falls short of our quality standards. That said, the stock currently trades at $4.25 per share (or a forward price-to-sales ratio of 0.8×). The market typically values companies like Magnachip based on their anticipated profits for the next 12 months, but it expects the business to lose money. We also think the upside isn’t great compared to the potential downside here - there are more exciting stocks to buy. We’d suggest looking at the most dominant software business in the world.

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