In some respects, analog chips are the workhorses of the semiconductor world. When the chip market goes into its regular troughs, the analog makers like Analog Devices (NYSE:ADI) batten down the hatches, and prepare for a few quarters of sequential earnings decline before the inevitable stabilization and recovery. Although the global economic situation is precarious, Analog may largely be through the process of seeing order levels reset ahead of a recovery.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Tough Close to a Challenging Year
There wasn't all that much good news in this fiscal fourth quarter for Analog Devices. Revenue fell 7% from last year and 6% from the preceding quarter. Sales were weakest in the industrial and communications categories, where both saw double-digit year-on-year declines. Sales to automobile manufacturers were quite strong, though, and sales to the consumer category were mixed - better from the fiscal third quarter, but down from last year.

One of the persistent worries about the major analog chip companies (including Linear Technology (Nasdaq:LLTC) and Microchip Technology (Nasdaq:MCHP) is the health of margins. To that end, the roughly three-point decline in gross margin from last year and last quarter was not great, but it has been worse in prior down cycles. Operating income fell by mid-teens percents on both comparisons, and the company saw about four points of operating margin erosion. (To know more about income statement, read Understanding The Income Statement.)

Still Ample Reason to Worry
Analog Devices matched most of its big chip peers in lowering guidance for the next quarter. What is somewhat worrying about these results is how broad the declines are. The annual and sequential comparisons were largely equal across all major product categories like converters, amplifiers and digital signal processors.

What's more, the improvement in the auto business needs to be seen in the context of the disruptions from the earthquake and tsunami in Japan, almost a year ago. And then there's the consumer business - that year-on-year decline seems like a warning that this won't be a great Christmas for consumer electronics.

The real question is whether customers have basically reset inventories and order levels to a sustainable level. That's often the big question for analog makers - both the Big Three and smaller players like Avago Technologies (Nasdaq:AVGO), Fairchild Semiconductor (NYSE:FCS) and ON Semiconductor (Nasdaq:ONNN). When economic activity picks up, customers over-order and take on inventory to make sure they have enough components. When activity slows, they burn through those stored up chips.

Most industrial companies seem to be cautiously optimistic about the next year, and see continued growth on the back of a strong emerging market demand. If so, that should be good news for the likes of Analog Devices, Linear and ON Semiconductor - companies with large industrial exposure and double-digit sales declines recently in this category.

The Bottom Line
If chip stocks are bottoming, then there are plenty of recovery plays to consider. The trouble with the analog category, and Analog Devices, is that it's not an area of the chip world that attracts most tech growth investors. These stocks don't generally get pounded quite so badly in the declines, but they also don't rebound nearly so much in the recoveries - and those worries about the sustainability of margins seem ever-present.

Analog Devices is a fine, undervalued company and arguably a decent play on the eventual chip sector recovery. Moreover, if the global economy doesn't really rebound much in 2012, there is probably less downside here than in hotter chip names. Altera (Nasdaq:ALTR), Atmel (Nasdaq:ATML) and Cavium (Nasdaq:CAVM) may have more potential in a rising market, but investors unwilling to commit fully to the recovery thesis might want to have at least some funds in a more conservative play like Analog Devices or Linear Technology. (For additional reading, check out: Great Company Or Growing Industry?)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Will WYNN Continue to Rally?

    Wynn Resorts has experienced a rally recently. Will it remain a good bet?
  2. Stock Analysis

    Don't Be Fooled by the Market's Recent Rally

    The bulls won for a bit in early October, but will bears have the last laugh?
  3. Stock Analysis

    Will Twitter's Stock Find its Wings Soon?

    Twitter is an enigma to many investors, but its story is pretty straightforward.
  4. Stock Analysis

    8 Solid Utility Stocks for a Bear Market

    If you're seeking modest appreciation, generous dividend payments and resiliency, consider these eight utility stocks.
  5. Stock Analysis

    Why Phillips 66 (PSX) is a Solid Long-Term Bet

    Here's why Phillips 66 will likely remain one of the world’s largest and most profitable companies for a long time to come.
  6. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  7. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  8. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  9. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  10. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!