Semiconductors are on the way back in 2012, but timing is still a major factor in making these investments work. Silicon Labs (Nasdaq:SLAB) is a frustrating case in that regard. While few (if any) chip stocks have a better near-term organic growth story, the stock has already been on a solid run since the fall of 2011. While further multiple expansion is possible, recent performance may be tough to replicate.
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.
A Stronger Close to the Year than Most
While most chip stocks are reporting a washout December quarter, Silicon Labs had the impertinence of reporting actual growth. Revenue rose 6% from the third quarter, as relatively strong results in video tuners and touch controllers drove results above even management's flat guidance.
Profitability was a little mixed, but solid overall. Gross margins slid both on an annual ((down 260 basis points (BPS)) and sequential (down 30 BPS) comparison. Silicon Labs' management did a good job of holding the line on operating expenses, though, and operating income rose 9% on a sequential basis and the margin expanded a bit. (For related reading, see Analyzing Operating Margins.)
How Far Can Touch and TV Go in 2012?
Given the consistent news from companies as diverse as Corning (NYSE:GLW), LG, Philips (NYSE:PHG) and Best Buy (NYSE:BBY) that the TV market is awful, it may seem odd to think that this is a growth market for Silicon Labs in 2012. Such is the power of winning sockets in new product launches. Accordingly, a poor TV market is still good enough for them, and a rebound in the market would be just more upside on top of that.
In touch, it's a different story. Silicon Labs has made some significant strides here and captured a fair bit of low-end business from Samsung. The question is how much further Silicon Labs can take this business. On one hand, this company should have an easier time integrating the MCU and IR sensors on a single chip than rivals Atmel (Nasdaq:ATML) or Cypress (Nasdaq:CY). On the other hand, the company doesn't seem as competitive on the high-end.
Consequently, it would not be surprising to see Silicon Labs gain more share in lower-range products, but may not be able to displace Atmel up the value chain. Still, there's quite a lot of business available there for Silicon Labs.
A Different Analog Play
Silicon Labs is a fabless ((Taiwan Semiconductor (NYSE:TSM) handles their manufacturing)) analog player with a definite twist. Much more focused than Analog Devices (NYSE:ADI) or Texas Instruments (NYSE:TXN), Silicon Labs looks for high-volume vertical markets instead of a broad horizontal exposure. The company is also different in its focus on CMOS (complementary metal oxide silicon) - it's an irritatingly difficult process for most mixed-signal chips, but offers an attractive cost/benefit tradeoff when done well.
The Bottom Line
Silicon Labs has always been a little different; more than once in its corporate history, management has basically jettisoned businesses that they thought were getting commodified and unattractive. This has added some instability to the model, but arguably kept the growth outlook stronger than at many other analog names.
All of this is all well and good, but it doesn't speak to valuation. Unfortunately, Silicon Labs is not looking very cheap on the basis of potentially conservative assumptions. With an addressable market of about $7 billion, I expect the company to have about 10% by 2016, with solid free cash flow margins on par with Texas Instruments or Marvel (Nasdaq:MRVL). All of that means a cash flow-based price target in the high $40s and little undervaluation at the present. That said, from a practical standpoint, if it continues to beat expectations, the estimates and valuation multiples will expand and the stock could continue to do well. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.