It looks like the third week of January is when a little good news came back into the semiconductor world. Though Altera (Nasdaq:ALTR) and Texas Instruments (NYSE:TXN) previously suggested the worst was about to be over, ironically while lowering guidance for the fourth calendar quarter, equipment vendor ASML (Nasdaq:ASML) and analog chip company Linear Technology (Nasdaq:LLTC) gave outright encouraging news with their respective quarterly reports.

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Results Still Not Exactly Pretty
To be sure, enthusiasm about the Linear story is about what's going to happen and not about what did happen. Results in the company's fiscal second quarter weren't that great, as revenue dropped 11% on a sequential basis and 23% on a year-on-year comparison. The revenue shortfall was largely just a byproduct of ongoing industry de-stocking throughout industrial, communications, auto and other markets.

Linear does boast some of the best margins in the chip sector, but operating leverage is hard to maintain on weaker sales. To that end, gross margin slid almost a point sequentially and dropped about three and a half points from last year. Operating results were likewise weak; operating income fell 16% sequentially (34% from last year) as the operating margin contracted two and a half and seven points, respectively. (For related reading, see Analyzing Operating Margins.)

And Now for Something Completely Different
Linear management was actually quite positive on order growth and prospects for the next fiscal quarter, lifting their guidance above where the analysts had previously been. To be sure, management is not exactly doing a victory lap; end-user demand has not rebounded that strongly yet and much of the increased order intake is inventory re-stocking necessary to keep production going.

Still, good news is good news. What's more, industrial companies have been getting incrementally more comfortable with 2012 guidance; Europe is a big worry, but markets like automation, industrial process control and so on, seem quite solid in North America. Moreover, autos seem like they've moved past the worst of the cycle.

If this all holds true, if industrial and auto orders are picking up, this is good news for Linear peers like Analog Devices (NYSE:ADI), Freescale (NYSE:FSL), Microchip Technology (Nasdaq:MCHP) and Texas Instruments. Keep in mind, too, that Linear has generally been a pretty good indicator when it comes to the ups and downs of the cycles, so while there's bound to be some individual variation, this management is usually pretty reliable.

Long-Term Worries Not Going Away
Although Linear has a great record and reputation, it's also something of a pinata for the sell-side. Linear is the fifth-largest analog company out there, but it could be a fair bit bigger if management wasn't so willing to walk away (or let customers walk away) from business that doesn't meet its margin requirements. Although the company has a remarkable record of defying analyst expectations of margin erosion, it's probably fair to acknowledge that further margin expansion is going to be difficult.

Still, just because Linear is committed to its plan does not mean that it's fossilized in place. The company recently announced the acquisition of Dust Networks, a company involved in low-power wireless sensor networks that allow machines to communicate with other machines. Linear didn't pay a lot (only about $25 million), but this could become a big deal in a few years. Moreover, I can't immediately recall the last time that Linear did a deal, so any deal there is a big deal. (For related reading on acquisitions, see The Merger - What To Do When Companies Converge.)

The Bottom Line
With top-five share in market categories like power management, amplifiers, data converts and comparators, Linear is a very high-quality analog chip name. Unfortunately, investors had already been bidding these shares up a bit in anticipation (or blind hope) of positive news from this quarter.

Given where the stock is trading now after earnings, there is some upside left, but not a lot. Investors looking to put new money into the chip sector should probably shop around a bit as there are better bargains out there today.

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



Tickers in this Article: LLTC, ADI, TXN, MCHP, FSL, ALTR, ASML

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