The still-awaited semiconductor recovery is certainly taking its sweet time in getting here. In the meantime, Analog Devices (NYSE:ADI), one of the leaders in the analog space, remains in something of a holding pattern. Although the stock has done pretty well as investors look forward to better utilization driving higher margins and larger cash returns to shareholders, the business is still waiting to see sustained demand improvement in its end markets.

A Fiscal Q2 That Was Good Enough
Analog's second quarter was fine, but that's about as positive as I can be about it and at least for now, “good enough” is good enough.

Revenue fell 1% from the year-ago level, but rose 2% sequentially and just barely squeaked out a beat versus the average of Street estimates. Industrial was a little soft (up 1% qoq), auto and consumer were basically in line (down about 2% and 1% qoq, respectively), and communications was stronger (up 12% qoq) than expected. By product type, Analog saw good growth in power management (up 5%), while converters were softer (up 1%).

SEE: Industry Handbook: Semiconductors

With volume hardly picking up to a meaningful extent, utilization is going nowhere fast. With that, it's not surprising that gross margin picked up only half a point from the prior quarter (and matched the analysts' estimate). Operating income fell 5% from last year, but rose 9% sequentially as the company slightly underperformed expectations with higher operating expenses.

Guidance A Little Underwhelming
ADI didn't give investors much cause for celebration with the guidance for the next quarter. Although the revision still suggests growth above traditional seasonal rates, the 2% sequential revenue growth was below the 4% Wall Street had been expecting.

Analog Devices saw good communications demand this quarter, helped by 3G demand in China, LTE demand in the U.S., and 100G deployments, but it looks like the consumer business is going to weaken further in the next quarter. That's doesn't sound like great news for ON Semiconductor (Nasdaq:ONNN), which has a large consumer exposure, but Analog's mention of “OEM timing issues” on product roll-outs gives some hope that it's a more Analog-specific issue. That said, it's worth noting that there has been a lot of speculation on the sell-side that Analog has lost a meaningful chunk of business with Apple (Nasdaq:AAPL) for the new upcoming iPhone(s).

The Street Already Expects Quite A Bit
If there's a problem with Analog, it's in what investors have already factored into the stock. Everybody knows that Analog has made progress with its operating expenses – not to the same degree as Linear (Nasdaq:LLTC), but progress all the same. Likewise, the potential gross margin leverage tied to higher utilization is no secret either.

As semiconductor stocks often anticipate these developments, I'm not sure that there's much more to go right for the company and stock other than an unexpected acceleration in demand. With that, I wonder if it's time to consider other ideas. Linear, for instance, seems to have better growth and market share prospects than commonly thought, and I could likewise see ON Semiconductor or Fairchild (NYSE:FCS) delivering better results than currently expected (or factored into the stock). None of this is a swipe at Analog Devces, by the way, as I just believe that most of the good things that can happen here are already known and anticipated by the Street.

The Bottom Line
I've bumped up my expectations for Analog a bit, to over 4% long-term revenue growth and 6% free cash flow growth, but the resulting fair value of about $47.50 isn't that exciting given how close it is to today's price. Analog isn't a bad hold, but investors who want outsized capital gains from a semiconductor stock probably need to look elsewhere right now.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.
Tickers in this Article: ADI, LLTC, ONNN, FCS

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