It looks like semiconductor slowdown worries are mostly in the past. Looking across the chip space, particularly the analog sector, most of the major players are either at or very near 52-week highs. While Avago (Nasdaq:AVGO) is likewise near its high for the year, investors may nevertheless want to look a little further and see whether this name might offer a relative bargain in this sector.
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An Okay Quarter To Close The Year
Avago's fiscal fourth quarter earnings showed a familiar theme in the chip sector - good year-over-year growth, okay sequential growth and a warning of sequential contraction early in 2011. More specifically, the company reported that total revenue grew 4% on a sequential basis (up 34% from last year), as sales into the wired segment grew 15% from the Q3 while consumer and computing sales dropped 22%.
Profitability fared better, though. Gross margin improved whether an investor looks at the GAAP, non-GAAP or adjusted non-GAAP numbers. The GAAP numbers show a 50 basis point sequential improvement and a substantially better jump from the year-ago level. Avago also reported more positive leverage through the operating and net income lines.
The Road Ahead
In some respects, Avago is another analog chip company like Linear Technology (Nasdaq:LLTC), Texas Instruments (NYSE:TXN) or Maxim (Nasdaq:MXIM). Avago sells into the industrial, automotive, wired/wireless infrastructure and consumer/computer verticals, and the company boasts thousands of chip products. Avago does have its areas of focus, though, including III-V based products and strong businesses in radio frequency and optoelectronics. What's more, the company is increasing its focus in areas like smartphones (where Research in Motion (Nasdaq:RIMM), Motorola (NYSE:MOT) and Samsung are already customers), and management seems focused on trying to increase the number of proprietary products offered.
Still, Avago is a chip company, and the technical details are often lost in the simplistic "chips good? chips bad?" trends that dominate the sector. In that respect, above-average growth, improving margins, an improving balance sheet and good management should help the company get more than a passing glance by shareholders. Moreover, with a diversified customer and product mix, there is a little less risk to this story than with more focused competitors. After all, customers like Cisco (Nasdaq:CSCO) may be looking a little ragged right now, but others like ABB (NYSE:ABB) and Siemens (NYSE:SI) are doing fine. (For more, see The Industry Handbook: The Semiconductor Industry.)
The Bottom Line
For better or worse, Avago sells a lot of chips that cost only a few bucks each, so particular products or sockets like optical finger navigation at RIMM do not matter all that much in the long run. What does matter, though, is the company's ability to produce good margins, solid returns on capital and reliable free cash flow. In those respects, Avago does well. These shares do not look radically undervalued right now (trading at about 85% of fair value), but they are still a relative bargain in the sector, and investors looking to make new bets on the chip sector ought to give this name some thought. (For more, see The Characteristics Of A Successful Company.)
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