Does Maxim Offer Something For Everybody?

By Stephen D. Simpson, CFA | October 25, 2012 AAA

Having a favorite semiconductor stock today is sort of an odd concept, as the entire sector has had a tough go of it this year and analysts are increasingly worried about prospects for a 2013 recovery. Nevertheless, Maxim (Nasdaq:MXIM) continues to pick up share with its integrated solutions, and the company offers an attractive dividend yield. While valuation and a high consumer concentration are causes for concern, this may yet turn out to be a very interesting stock in a highly-challenged sector.

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This Is What Passes for a Strong Third Quarter in Chips
Although Maxim did not have an especially strong quarter in an objective sense, the company did reasonably well relative to expectations and its guidance revision was one of the more benign ones in the sector. With so very few chip companies in a position to have a great quarter, Maxim did at least do well on a relative basis. Revenue fell 2% from last year, but rose about 3% from the second quarter, just a tick above average expectations. Maxim saw great growth in consumer, fueled at least in part by Samsung's Galaxy S3. Everything else was weaker, though, as communications, computing, and industrial saw declines due to broad-based weaknesses. Maxim also did quite well on margins though. Gross margin decreased a bit from last year, but improved slightly on a sequential basis, while adjusted operating income decreased just slightly from last quarter as well, but rose by about 22% annually. All in all, Maxim beat expectations at both the gross and operating margins lines.

A Relatively Mild Guidance Cut, but Dangers Lurk
Relative to other analog players like Linear Technology (Nasdaq:LLTC) and Texas Instruments (NYSE:TXN) and even fellow smartphone/tablet player Broadcom (Nasdaq:BRCM), Maxim management offered a pretty mild guidance revision. Numbers are going down, but management expects sales to be flat to down 2% on a sequential basis - much better than the 5% to 10% declines projected by many other chip companies this quarter. However, don't let that guidance lull you into complacency. Management cited weakening end-user demand in industrial (nearly one-quarter of sales) and communications infrastructure is looking pretty shaky as well. Computing continues to be weak, and investors have gotten considerably more cautious as to whether Intel (Nasdaq:INTC) and Microsoft (Nasdaq:MSFT) can really reignite the space.

Last and not least, Maxim has become increasing dependent on mobile devices. Consumer devices are nearly 50% of revenue now, with a very large concentration at Samsung. While Maxim has been more successful than it gets credit for when it comes to winning sockets at other device designers such as Apple (Nasdaq:AAPL), it's still worth pointing out that slowing sales of smartphones/tablets or just worse sales at Samsung would be a bad development.

Building a Better Business for Tomorrow
Although I think the next few quarters could still be shaky (like as not from over-eager sell-side analysts hoping for a rebound), I like what Maxim is doing from a strategic perspective. The company's focus on integrated solutions plays directly into what companies such as Apple, Samsung and Amazon (Nasdaq:AMZN) want - more efficient power consumption and smaller footprints, with no compromises in functionality. At the same time, while the much greater share of Texas Instruments and Analog Devices (NYSE:ADI) in areas such as power conversion, data conversion and amplifiers is a threat, Maxim can benefit from second-source awards and innovation.

The best thing Maxim could likely do now is gain more share at non-Samsung designers. There's nothing wrong with being a supplier to Samsung (as the company trades leadership with Apple from month to month), but Samsung has a habit of internalizing its own needs over time. Maxim has seen its per-device content increase at Samsung, but becoming a little like Broadcom or Qualcomm (Nasdaq:QCOM) in terms of customer diversification would certainly help.

The Bottom Line
I like the business at Maxim, but I don't find the stock quite as appealing. High single-digit free cash flow (FCF) growth supports a fair value in the low $30s, which doesn't make the stock as compelling as that of Broadcom or LSI (NYSE:LSI). Maxim's erratic year-to-year changes in free cash flow margin make it more difficult to project more robust improvement, but if Maxim can continue to gain share with integrated solutions, the stock could yet be poised to be an outperformer in the coming years.

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

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