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Analog Devices: Will Chips Get Clipped?
Will the real semiconductor market please stand up?
On one side of the hall, analysts are lining up to predict a slowdown (if not decline) for chip companies in the second half of this year. On the other side, companies ranging from Linear Technology (Nasdaq:LLTC) to Texas Instruments (NYSE:TXN) to ON Semiconductor (Nasdaq:ONNN) have reported solid earnings and basically positive guidance.
IN PICTURES: 9 Simple Investing Ratios You Need To Know
Given that Analog Devices (NYSE:ADI) is both large and a bit off the regular reporting cycle, perhaps this company's outlook will add a bit of clarity to the situation.
The Quarter that Was
Analog posted another solid quarter. Revenue climbed 8% sequentially (about 46% annually) and surpassed the consensus guess on The Street. Growth was supported by 14% sequential improvement in the communications business (roughly 20% of the total business), and an 8% sequential boost in the larger industrial business (nearly half of total revenue).
The good news continued below the top line. Gross margin improved another 170 basis points from the prior quarter, and ADI delivered a 17% jump sequential jump in operating income. Analog also continues to accumulate cash, ending the quarter with around $7 per share in net cash.
The Road Ahead
All things considered, ADI's forward guidance was pretty similar to Texas Instruments and Linear - not surprising given that these companies are in similar businesses (though Texas Instruments is a fair bit larger than the other two). More specifically, management talked about orders from industrial customers like ABB (NYSE:ABB) and Emerson (NYSE:EMR) and pointed out that their orders were in line with the order flow they were seeing from end-user customers - suggesting that there is not a lot of channel-stuffing in the industrial business.
On top of that, ADI management also indicated that they believed they were picking up some business from shortages at rival companies. That is an interesting comment, as it would seem to refute the idea that a lot of chip companies are selling into inventory and will hit a wall in the second half of the year.
The Bottom Line
So, who is right? Neither analysts nor chip industry executives have an unblemished record when it comes to predicting the future. Moreover, given that customers increasingly look to keep leaner inventories, there might be less lead time and visibility for all observers. In other words, a downturn in the economy could hit the chip business faster than people think.
Still, ADI is a quality business - it has excellent marketshare in converter chips and the company has seen interesting cross-pollination in its markets. ADI developed accelerometer chips for the automotive industry, but descendants of those chips are now found in consumer devices like the Nintendo Wii and the Apple (Nasdaq:AAPL) iPhone. Investors should not necessarily bank on that sort of migration on a regular basis, and ADI is so large that single applications have limited impact, but it does highlight the benefit of strong ongoing R&D and a huge diversity of product offerings.
Is ADI a buy today? The stock is definitely at a price that looks pretty interesting for the next few years. The real dilemma is whether there will be a second-half slowdown. Investors who can stomach such a pullback could buy today (or buy a partial position), but more aggressive investors may want to wait for another pullback and take the risk that it never materializes. (For more, see Great Company Or Growing Industry?)
On one side of the hall, analysts are lining up to predict a slowdown (if not decline) for chip companies in the second half of this year. On the other side, companies ranging from Linear Technology (Nasdaq:LLTC) to Texas Instruments (NYSE:TXN) to ON Semiconductor (Nasdaq:ONNN) have reported solid earnings and basically positive guidance.
IN PICTURES: 9 Simple Investing Ratios You Need To Know
Given that Analog Devices (NYSE:ADI) is both large and a bit off the regular reporting cycle, perhaps this company's outlook will add a bit of clarity to the situation.
The Quarter that Was
Analog posted another solid quarter. Revenue climbed 8% sequentially (about 46% annually) and surpassed the consensus guess on The Street. Growth was supported by 14% sequential improvement in the communications business (roughly 20% of the total business), and an 8% sequential boost in the larger industrial business (nearly half of total revenue).
The Road Ahead
All things considered, ADI's forward guidance was pretty similar to Texas Instruments and Linear - not surprising given that these companies are in similar businesses (though Texas Instruments is a fair bit larger than the other two). More specifically, management talked about orders from industrial customers like ABB (NYSE:ABB) and Emerson (NYSE:EMR) and pointed out that their orders were in line with the order flow they were seeing from end-user customers - suggesting that there is not a lot of channel-stuffing in the industrial business.
On top of that, ADI management also indicated that they believed they were picking up some business from shortages at rival companies. That is an interesting comment, as it would seem to refute the idea that a lot of chip companies are selling into inventory and will hit a wall in the second half of the year.
The Bottom Line
So, who is right? Neither analysts nor chip industry executives have an unblemished record when it comes to predicting the future. Moreover, given that customers increasingly look to keep leaner inventories, there might be less lead time and visibility for all observers. In other words, a downturn in the economy could hit the chip business faster than people think.
Still, ADI is a quality business - it has excellent marketshare in converter chips and the company has seen interesting cross-pollination in its markets. ADI developed accelerometer chips for the automotive industry, but descendants of those chips are now found in consumer devices like the Nintendo Wii and the Apple (Nasdaq:AAPL) iPhone. Investors should not necessarily bank on that sort of migration on a regular basis, and ADI is so large that single applications have limited impact, but it does highlight the benefit of strong ongoing R&D and a huge diversity of product offerings.
Is ADI a buy today? The stock is definitely at a price that looks pretty interesting for the next few years. The real dilemma is whether there will be a second-half slowdown. Investors who can stomach such a pullback could buy today (or buy a partial position), but more aggressive investors may want to wait for another pullback and take the risk that it never materializes. (For more, see Great Company Or Growing Industry?)
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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