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Linear's Ups And Downs
For long-term shareholders, Linear Technology (Nasdaq:LLTC) is anything but linear. Although this company has a phenomenal record of producing top-notch margins, returns on capital and free cash flow, the reality is that the analog semiconductor business is cyclical and even a top operator cannot do anything about that. With disappointing (albeit not completely surprising) fiscal third quarter guidance, semiconductor investors are left wondering what 2011 will hold for the sector.
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The Quarter That Was
While it will likely be overshadowed by the guidance, Linear's reported second quarter results were actually quite good. Revenue fell 1% sequentially (and rose 50% annually) and beat the average estimate on the Street. Strong Apple (Nasdaq:AAPL) iPad sales no doubt helped, but the ongoing recovery in the industrial and automotive markets were more significant.
The company also did a solid job (as it almost always does) on profitability. Gross margin was flat sequentially at 78.5%, but up about 250 basis points from the year-ago level. Operating income did drop 2% sequentially (and jump 74% annually), but this was better than expected. At the bottom line, the company beat estimates, even after excluding a boost from lower taxes. (For more, see The Bottom Line On Margins.)
The Rocky Road Ahead
Although Linear's second quarter was solid, its is likely that guidance for the third quarter will dominate the story. While the Street had been expecting a 1-2% sequential decline, the company announced that revenue would fall 6-10% instead. There appear to be two primary causes for this negative outlook.
First, the company will no longer be selling into the Apple iPad 2. It would seem that Linear has effectively chosen to walk away from this business rather than cut prices (and margins). Although this sounds bad, it is not uncommon or unexpected for this company - it is entirely normal for Linear to have prominent slots in new products at launch, and then drop out as manufacturers look for lower-priced DC converters, USB controllers and so on. With peak revenue from this product likely in the $12 million to $18 million range, it's not a crushing loss but it still hurts.
Second, the company reported that lead times in the industrial, communications and automotive markets are getting back to normal. In essence, this means that customers are ordering less and holding less inventory because they are getting the chips they need with less delay. National Semiconductor (NYSE:NSM) reported similar destocking, and this could be a risk for other analog companies like Analog Devices (NYSE:ADI), International Rectifier (NYSE:IRF) and perhaps ON Semiconductor (Nasdaq:ONNN), though ONNN has other businesses to offset that. (For more, see Everything Has Caught Up To Analog Devices.)
The Bottom Line
With Linear's DSO's heading up and sales guidance heading down, there will no doubt be some fears that the semiconductor industry has once again reached a near-term peak. Although that fear is understandable to a point, and Linear has been a leading indicator in the past, a lot of the negative forward guidance seems company-specific. Moreover, Linear shareholders can take some small solace in the fact that Linear tends to outperform (that is, decline less) its peers during downturns. So, even if 2011 is shaping up as a tougher year for chips, LLTC could be a decent hiding place. (For more, see Avago Looks Like A Relative Bargain.)
Bears have long argued that there is little room for Linear to improve its margins and that it has to sacrifice revenue growth to maintain its margins (as it seems to be doing with Apple). Still, Linear stands out even among quality peers like Analog Devices, Fairchild (NYSE:FCS), Microchip Technology (Nasdaq:MCHP) and Silicon Labs (Nasdaq:SLAB) as a very well-run company.
Unfortunately, quality aside, Linear does not look like a great bargain anymore. While this is a fine stock for the watchlist (and may yet be worth holding for long-term investors who do not trade often), bargain hunters might find better quarry among the likes of Intel (Nasdaq:INTC) these days.
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IN PICTURES: 9 Simple Investing Ratios You Need To Know
The Quarter That Was
While it will likely be overshadowed by the guidance, Linear's reported second quarter results were actually quite good. Revenue fell 1% sequentially (and rose 50% annually) and beat the average estimate on the Street. Strong Apple (Nasdaq:AAPL) iPad sales no doubt helped, but the ongoing recovery in the industrial and automotive markets were more significant.
The company also did a solid job (as it almost always does) on profitability. Gross margin was flat sequentially at 78.5%, but up about 250 basis points from the year-ago level. Operating income did drop 2% sequentially (and jump 74% annually), but this was better than expected. At the bottom line, the company beat estimates, even after excluding a boost from lower taxes. (For more, see The Bottom Line On Margins.)
The Rocky Road Ahead
Although Linear's second quarter was solid, its is likely that guidance for the third quarter will dominate the story. While the Street had been expecting a 1-2% sequential decline, the company announced that revenue would fall 6-10% instead. There appear to be two primary causes for this negative outlook.
First, the company will no longer be selling into the Apple iPad 2. It would seem that Linear has effectively chosen to walk away from this business rather than cut prices (and margins). Although this sounds bad, it is not uncommon or unexpected for this company - it is entirely normal for Linear to have prominent slots in new products at launch, and then drop out as manufacturers look for lower-priced DC converters, USB controllers and so on. With peak revenue from this product likely in the $12 million to $18 million range, it's not a crushing loss but it still hurts.
Second, the company reported that lead times in the industrial, communications and automotive markets are getting back to normal. In essence, this means that customers are ordering less and holding less inventory because they are getting the chips they need with less delay. National Semiconductor (NYSE:NSM) reported similar destocking, and this could be a risk for other analog companies like Analog Devices (NYSE:ADI), International Rectifier (NYSE:IRF) and perhaps ON Semiconductor (Nasdaq:ONNN), though ONNN has other businesses to offset that. (For more, see Everything Has Caught Up To Analog Devices.)
The Bottom Line
With Linear's DSO's heading up and sales guidance heading down, there will no doubt be some fears that the semiconductor industry has once again reached a near-term peak. Although that fear is understandable to a point, and Linear has been a leading indicator in the past, a lot of the negative forward guidance seems company-specific. Moreover, Linear shareholders can take some small solace in the fact that Linear tends to outperform (that is, decline less) its peers during downturns. So, even if 2011 is shaping up as a tougher year for chips, LLTC could be a decent hiding place. (For more, see Avago Looks Like A Relative Bargain.)
Bears have long argued that there is little room for Linear to improve its margins and that it has to sacrifice revenue growth to maintain its margins (as it seems to be doing with Apple). Still, Linear stands out even among quality peers like Analog Devices, Fairchild (NYSE:FCS), Microchip Technology (Nasdaq:MCHP) and Silicon Labs (Nasdaq:SLAB) as a very well-run company.
Unfortunately, quality aside, Linear does not look like a great bargain anymore. While this is a fine stock for the watchlist (and may yet be worth holding for long-term investors who do not trade often), bargain hunters might find better quarry among the likes of Intel (Nasdaq:INTC) these days.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
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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