Everything Has Caught Up To Analog Devices

By Stephen D. Simpson, CFA | November 24, 2010 AAA

It was not all that long ago when Analog Devices (NYSE:ADI) looked like a relatively undervalued play in the chip sector and good candidate for more conservative investors wanting tech exposure. When I last wrote on Analog in mid-August, I was positive on the stock and shares have jumped about five points (nearly 20%) since then. While a lot of the easy short-term money may already be in the bank, there are still solid reasons for investors to keep a careful eye on this name.

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As Expected, A Solid Quarter
Analog delivered yet another solid quarter to close out its fiscal year. Revenue jumped 35% from the year-ago level, and rose 7% on a sequential basis. Growth was led once again by strong results in communications, where revenue rose 19% sequentially on the back of demand in applications like base stations (likely good news as well for Powerwave (Nasdaq:PWAV)). Auto sales were also strong, with a 12% sequential improvement, while industrial and consumer were up 3% and 2% respectively.

Analog took another strong step forward in profitability. Gross margin improved by 30 basis points, and operating income more than doubled. At just over 37%, operating margin is not only exceptionally strong but more than 10% above prior peak levels. Last and by no means least, the company continues to accumulate cash and ended the year with about $9 a share in cash on the balance sheet.

The Road Ahead
There are ample signs that user demand has caught up to the chip space and orders and lead times have shrunk. Analog's book to bill was below 1, though the company did report some stabilization in November. Looking at Cisco's (Nasdaq:CSCO) guidance, there could be some cause for concern in parts of the communications sector, though the likes of F5 (Nasdaq:FFIV) and Aruba Networks do not seem to be having the same trouble. Elsewhere, cautious buying from consumers may be reason to wonder whether these companies are nervous about building inventory going into the Christmas season. Either way, keep an eye on names like Apple (Nasdaq:AAPL), Nintendo (OTC:NTDOY), Corning (NYSE:GLW), and AU Optronics (OTC:AUO) as both bellweathers and co-travelers in this segment.

All in all, though, there is not a lot to surprise in Analog's report (apart, perhaps, from the great margins). Analog's guidance is not much different than that from other major analog companies like Texas Instruments (NYSE:TXN) or Linear Technology (Nasdaq:LLTC), and it is clear that the catch-up period of demand growth is over. Nevertheless, looking at the reasonably encouraging guidance that is coming from industrial companies like Emerson (NYSE:EMR), it seems that growth in the next year is still quite probable.

The Bottom Line
It is possible that Analog has seen the peak for this cycle, but investors should remember that Analog has a long record of growth through many semiconductor cycles. The easy money is likely gone from these shares, but this is a quality company that is always willing to shuffle the deck to improve the business. Investors may want to wonder if the company has plans for that large cash balance and may be right that the company is too large to be a rampant grower, but this still looks like a quality name that is worth accumulating on the dips. (To learn more, check out The Industry Handbook: The Semiconductor Industry.)

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