Can Maxim Outgrow Its Cycle?

By Stephen D. Simpson, CFA | January 25, 2011 AAA

Looking at calendar fourth quarter results so far, there is definitely a little cause for concern about the cyclical slowdown. That puts Maxim Integrated Products (Nasdaq:MXIM) investors in the midst of a bit of a quandary - will product wins in popular consumer products like smartphones, TVs and tablets be enough to overpower cyclical pressures, or is the company just going to go through the same trouble a little later?

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The Quarter That Was
Maxim reported a pretty solid fiscal second quarter. Revenue was down 2% on a sequential basis, but up 29% from last year and a bit ahead of the published average analyst guess. Communications was a standout (up sequentially by 3%), while computers were notably weak - especially notebooks. Profitability was not bad either. GAAP gross margin did improve a bit on a sequential basis, but operating income did fall even after excluding some unusual items. (For more, see The Chips Are Down.)

There were a few concerning items in the details, though. The company reported that bookings dropped 15% on a sequential basis and the book-to-bill was 0.85. Lead times continue to fall and stood at 12 weeks - off a bit from the company's peak of 14, but still ahead of the "normal" level of 8-9 weeks. That is a definite risk factor for the stock - as customers can more easily get the chips they need (and get them on time), they do not need to over-order or carry larger inventories. That in turn leads to order cancellations and revenue stress.

The Road Ahead
Order times are not the only concern for Maxim investors to consider. Texas Instruments (NYSE:TXN) is building a large 300mm fab (which FBR's analyst Craig Berger has called the "Death Star") and that could produce some supply-driven pressure on the sector. Arguably Maxim would be more vulnerable than Linear Technology (Nasdaq:LLTC) and Analog Devices (NYSE:ADI) but it is hardly good news for any supplier other than TI. (For related reading, see Linear's Ups And Downs.)

Of course, there is also market demand risk. Customers like LG and Samsung have done well with their handsets and LCD TVs and there is optimism about their tablets. However, given how often words like "sales" and "surprise" go together, there is no guarantee that these markets will stay strong or that LG/Samsung gain share.

All of that being said, Maxim has a lot going for it. The company is gaining share in lucrative markets, and design wins in smartphones, TVs, tabletsa and industrial growth markets like smart meters will pay dividends. Moreover, in comparison to hot smartphone/tablet plays like ARM Holdings (Nasdaq:ARMH), Qualcomm (Nasdaq:QCOM) or Broadcom (Nasdaq:BRCM), Maxim seems like something of a bargain. (For related reading, see ARM'ed And Dangerous.)

The Bottom Line
Investors who believe Maxim can lever these design wins into more market share, more profits and more cash flow should probably hold on to these shares. There is a risk that this mid-cycle reset could be worse than investors expect (particularly if cycle-leader Linear's guidance proves to be less company-specific than people presently think), and that should not be ignored. For now, Maxim shares look a little cheap; a move to "really cheap" would require conviction and evidence that the company can produce free cash flow at a rate closer to that of Linear or Analog Devices. It is not unthinkable, but it could put Maxim into a tough place where it has to choose between margin expansion and top line growth. (For more, see Is Linear A Canary Or A Duck?)

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