As a semiconductor stock with strong ties to the smartphone/tablet market, Avago (Nasdaq:AVGO) has been a part of that favored group of chip stocks ((which includes Qualcomm (Nasdaq:QCOM) and Skyworks (Nasdaq:SWKS)) that has generally outperformed its peers. Not only did Avago deliver growth in a tough quarter, but smartphone wins could make 2013 a strong year as well. Betting on better conditions for chip stocks has been a losing bet for most of 2012, but Avago remains a name worth knowing for more risk-tolerant investors.
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Avago Delivers a Good Ending to the Fiscal Year
Avago continues to prosper from socket wins at leading smartphone designers like Apple (Nasdaq:AAPL), Google (Nasdaq:GOOG), and Samsung. That is helping to ameliorate the damage from tougher conditions in networking and industrial/auto markets.
For the quarter, Avago reported that sales fell 1% in comparison the year-ago quarter, but rose 2% from the July quarter. Sales were led by wireless (the only positive category), as sales jumped 30% from the July quarter on strong Apple and Samsung sales. Sales in the wired group fell 8%, while industrial/auto sales fell 11%.
Margin pressure is nothing new in this business, but Avago managed it reasonably. Avago's GAAP gross margin fell 30 basis points (BPS) sequentially and 40 BPS from the year-ago quarter, but that was basically in line with expectations. Operating income rose 9%, though, and the nearly two points of sequential operating margin improvement was about a point better than expected.
Guidance Down, but not too Disappointing
While Avago did lower guidance for the next quarter, that has been commonplace in the chip sector lately ((Analog Devices (Nasdaq:ADI) posted a pretty sharp revision with its earnings recently)). Taking the midpoint of management's guidance ($575 million), that's a nearly 6% negative revision relative to prior expectations.
Can 2013 Be a Strong Year for 2013?
Investors and analysts have definitely started to cool their enthusiasm for 2013, as numerous companies have lowered expectations on various U.S. and global macroeconomic worries. That said, there could be some reasons for optimism in the case of Avago.
For starters, the company's wins in 4G-LTE phones should continue to pay bigger dividends in 2013, allowing wireless to continue to drive growth. Unless investors believe that the smartphone market is going to really slow next year (particularly for the leaders like Apple and Samsung), that should be a pretty safe estimate (to the extent that any prediction about a chip stock can be safe).
One note of caution though - management has increased its capacity plans for FBAR filters from a doubling to a quadrupling. It's hard to believe that management would do this without talking to major clients like Apple and Samsung and feeling confident about future demand, but the risk of potentially under-utilized capacity is a real one.
On the more speculative side, it looks like carrier spending is finally picking up, and that should be good for Avago's business with Cisco (Nasdaq:CSCO) and Juniper (NYSE:JNPR). I also believe that Avago could get solid business from data center upgrades that would further stimulate that wired segment. Last and not least, the industrial and auto markets could perk up, particularly in the second half of 2012.
The Bottom Line
It's not too hard to find chip stocks that look like bargains today, but I think Avago's apparent value is underpinned at least somewhat by the good, real growth in its wireless business today. What's more, even modest growth assumptions relative to other smartphone chip players like Broadcom (Nasdaq:BRCM) and Qualcomm support a price target in the low to mid $40s.
Although Avago seems to be an overlooked chip play (it's twice as large as Skyworks, and about half the size of Broadcom), that's not such a bad thing for value hounds. Provided that Avago can maintain its edge in FBAR filters (and maintain a strong pricing advantage, which can be tricky in this business), this looks like an interesting name for both growth and value investors.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.