Cycle Risks Remain, But Analog Devices Has Solid Long-Term Credentials

There is certainly a faction of analysts and investors that perpetually view semiconductors as either in a downturn or heading toward the next downturn, and I suppose while that may be technically true, you will miss a lot of winners that way. That being said, it's equally foolish to ignore the cyclicality of the semiconductor space, as buying at the top can lead to a lot of years of lackluster performance.

I was neutral on Analog Devices (NASDAQ:ADI) back in April of 2021 mostly due to my concerns about a sentiment shift against semiconductors as investors would eventually come to the conclusion that unsustainable lead-times are, in fact, unsustainable and will eventually lead to an order correction cycle that would likely compress growth and margins for a time.

Since then, the shares have returned about 5%, underperforming the S&P 500 and the SOX, as well as some of the chip names I've preferred, including Broadcom (AVGO) and STMicro (STM). I'm still concerned about sentiment and the prospect of negative revisions when lead-times shrink, but this is definitely a name I'd at least follow now and seriously consider if there's another re-test of those lows in the $140's.

 

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Cycle Risks Remain, But Analog Devices Has Solid Long-Term Credentials

Analog Devices Ready To Leverage A Long-Term Inflection In Chip Demand

 

Only by the bubbly standards of the semiconductor sector could Analog Devices’ (ADI) performance since my late August piece be thought of as disappointing, as the shares have risen almost 40% - lagging the SOX index by around 10 points and likewise lagging other high-quality analog peers like Microchip (MCHP) and NXP Semiconductors (NXPI), with the latter almost certainly getting a boost from its greater leverage to an auto sector recovery.

Pretty much everything is going Analog’s way right now. There are supply constraints, but Analog seems better-placed than average to handle them, and while the communications end-market has remained volatile, 5G deployments are a “when, not if” driver. Meanwhile, auto and industrial demand is recovering, with a host of factors in place to drive content growth for several years.

There will likely be a rollover in the cycle at some point as lead times shrink (though maybe not until late in 2021 or early 2022), but that will be a pause in what I see as a strong “mega-cycle” of chip growth across multiple end-markets. On top of that, the Maxim (MXIM) deal should close this summer, giving the company some cost and revenue synergy opportunities.

Of course, valuation remains problematic. It’s not unusual for multiples to stretch in upcycles, and that’s what’s happening now. I won’t dismiss the possibility of a stronger-for-longer cycle, but I don’t think my 6% organic long-term core revenue growth rate, 45%+ adjusted operating margin, or 40% long-term adjusted FCF margin assumptions are particularly conservative, and the long-term returns just don’t look that exciting now.

 

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Analog Devices Ready To Leverage A Long-Term Inflection In Chip Demand

Analog Devices Betting That Bigger Is Better

Relative to, say, Broadcom (AVGO), Analog Devices (ADI) has been an infrequent acquirer in a semiconductor industry that has long seen significant consolidation and M&A activity. When they do act, though, they tend to make meaningful deals that pay dividends down the road (Hittite and Linear Tech). In looking to acquire Maxim (MXIM), I believe Analog is focusing relatively less on technology and know-how this time around in favor of a more scale-driven M&A argument.

I’m not worried about Analog executing on this deal, even if it does seem to be a little expensive to me. While the long-term benefits of this deal are likely to be less meaningful than those two prior deals, I do see it adding long-term value. Given the valuation of the shares, though, I can’t really get too excited about buying them today, even as business seems to be turning around.

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Analog Devices Betting That Bigger Is Better

Analog Devices Remains Well-Run And Well-Placed To Grow

Even when you’re talking about the best of the best, valuation still matters. While I liked the quality of Analog Devices (ADI) and its differentiated growth drivers a year ago, I wasn’t so fond of the valuation. Since then, the shares have given investors a roughly 15% return, which is better than the return of the S&P 500 over that time, but well below the 40%-return of the semiconductor sector (as measured/reflected by the SOX index).

My main concern today is that the sector (and the market in general) has come back too far too quickly, leaving the risk/reward balance skewed more to the downside, and particularly if the Covid-19 recession proves to be deeper and/or longer than expected. I still really like Analog as a company, though, and I’m excited by the company’s specific growth drivers and growth opportunities, as well as its high-quality management. Valuation makes it hard for me to call this anything more than a hold, but I suppose if I had to own an expensive analog chip stock, this would be my preferred pick.

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Analog Devices Remains Well-Run And Well-Placed To Grow

Analog Devices Already Well-Valued For Its Quality

There are certainly some bargains out there in the chip sector today, but I’m not finding many in areas like analog. To that end, while I have no qualms about the quality of Analog Devices (ADI), nor its prospects for above-average growth in the years to come, I find that the market is already on top of the story. I don’t think the shares are notably overvalued (unless the economy is teetering on the brink of outright recession), but given the ongoing risks in the sector and my preference for buying in at discounts to fair value, I don’t see a need to jump in here today.

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Analog Devices Already Well-Valued For Its Quality

The Market Seems To Be Counting On A Quick Rebound At Maxim Integrated

There are a lot of meaningful positives with Maxim Integrated (MXIM). Not only has this company successfully transitioned to a more attractive end-market mix driven by auto electrification and factory automation, the company has also meaningfully upgraded its profitability by pruning lower-return businesses, bringing more distributors into the mix, and outsourcing more production. With strong margins, above-average growth potential, and a strong business anchored in power management and interface ICs, I believe Maxim can do well on its own and/or become an attractive acquisition target.

All that said, there are limits to what I’ll pay and Maxim is trading beyond those limits. Recent results and guidance should serve as a reminder that Maxim’s better mix doesn’t immunize it from macro challenges, and I am concerned that investors have gotten too cavalier about assuming a quick return to growth across the chip sector. In the $50’s, Maxim just looks too expensive to me relative to the risks of further setbacks/revisions in the sector.

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The Market Seems To Be Counting On A Quick Rebound At Maxim Integrated

MaxLinear Marking Time Ahead Of Commercial Ramps In 2019/2020, But Spending Less

I've thought that MaxLinear (NYSE:MXL) held some potential for more risk-tolerant investors for some time, but I was surprised to see the strong (approximately 25%) move in the shares since my last update. Granted, chip stocks have done well over the past month, with the SOX up almost 20%, and I think investors liked the company's guidance for much better opex in 2019, but it's still worth noting that the growth story here is tied to wireless access, backhaul, and optical interconnect opportunities that won't really kick in until late this year and where MaxLinear has to show it can elbow aside established players like Analog Devices (ADI), Broadcom (AVGO), and Inphi (IPHI).

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MaxLinear Marking Time Ahead Of Commercial Ramps In 2019/2020, But Spending Less

A Brutal Miss-And-Lower-Guide Has Silicon Labs' Growth Premium In Question

It’s generally accepted by most investors that you have to pay up for growth, but with the recent weak performance at Silicon Labs (SLAB), including an ugly guide-down for the first quarter, I’m concerned that these shares could be liable to investors asking “wait … why are paying up for this?” I had previously expressed my view that Silicon Labs was entering a rocky operational stretch, but this is a little worse than I’d expected, and the company definitely needs markets like IoT, isolation, and timing to start coming through in the second half of 2019.

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A Brutal Miss-And-Lower-Guide Has Silicon Labs' Growth Premium In Question

Silicon Labs Continues To Build On Its Strengths

Committing to the Internet of Things (or IoT) has been a transformative decision for Silicon Labs (SLAB), as this smallish semiconductor company continues to leverage its broad wireless capabilities to benefit from the growth in IoT deployments. These shares are up more than 40% over the past year, and revenue looks on track to continue high single-digit to low double-digit growth for some time, pushed along by the strength in IoT, but also aided by exposure to markets like optical networking and electric vehicles. The company's recent announcement of the acquisition of Sigma Designs (SIGM) furthers the story, adding another wireless standard and a decent chunk of fast-growing revenue with expense synergies.

Silicon Labs has performed well relative to expectations, and the shares are being richly rewarded for the company's above-average revenue growth and improving margins. While I do expect high single-digit revenue growth over the long term (including Sigma) and double-digit free cash flow growth, valuation is definitely in the "bull cycle" part of the range, and I cannot find enough value to get comfortable with the idea of buying for my own account.

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Silicon Labs Continues To Build On Its Strengths

The Pieces Are In Place For Ongoing Success At Broadcom

It's hard to complain about Broadcom's (AVGO) performance, as this top-tier semiconductor company has seen its shares rise almost 45% since my last update in late 2016. While a few stocks have done better (NVIDIA (NVDA) certainly springs to mind), Avago has by and large doubled the returns of peers like Analog Devices (ADI), Cavium (CAVM), Texas Instruments (TXN), and Xilinx (XLNX). Better still, this is not just a multiple inflation story, as Avago has continued to deliver beat-and-raise performances that support confidence in the ongoing growth potential in areas like handsets and routing/switching.

I don't believe Broadcom is strikingly cheap, but then I wouldn't expect such a large, well-known, well-followed, and well-liked company to be trading at a substantial discount. I do believe ongoing content growth at Apple (AAPL), growth of products like Tomahawk and Jericho in the datacenter, and less appreciated opportunities like its custom ASIC business can continue to support story, and it's not a bad candidate if you find yourself in a “gotta buy something” frame of mind. After all, how often do you find a company that generates more than 60% of its revenue from products where it has 60% or better market share, growth rates above the underlying end-markets, and excellent margins?

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The Pieces Are In Place For Ongoing Success At Broadcom

Seeking Alpha: Without A Bigger Discount, Maxim Not So Interesting Today

Six months ago, I thought the Street had overreacted to disappointing results at Maxim Integrated Products (NASDAQ:MXIM) to such an extent that the stock looked like a good relative value in the space. Since then, the shares have done pretty well relative to its peer group - up about 15% while Linear (NASDAQ:LLTC) and Analog Devices (NASDAQ:ADI) were up in the single-digits and a stock I liked better, ON Semiconductor (NASDAQ:ONNN) rose about 16%.

Maxim is still facing the same basic set of challenges - finding new sources of growth now that Samsung is no longer likely to be a significant growth driver in the coming years. Maxim is saying and doing some of the right things, including getting out of low-margin businesses like consumer MEMS and touch and focusing on higher-growth opportunities in industrial and auto, but I'm concerned about the company's ability to truly differentiate itself. With the valuation looking pretty fair today, I don't dislike the stock but can't work up a lot of excitement to buy in today.

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Without A Bigger Discount, Maxim Not So Interesting Today

Seeking Alpha: Linear Technology's Opportunities, And Challenges, Remain The Same

Six months have passed since my last article and not too much has changed for Linear Technology (NASDAQ:LLTC) on a fundamental basis. The company still has some exciting opportunities in the industrial and automotive verticals, but is also facing serious competition from Texas Instruments (NASDAQ:TXN) and Analog Devices (NASDAQ:ADI) (among many others) and widespread doubts that the company can take industry-leading margins much higher.

I thought Linear was more or less fairly valued six months ago (the shares are up 2% since) and that is still my opinion. Improving growth in the U.S., particularly in the industrial vertical, ought to help but probably not enough to radically alter sentiment. The company does have a large amount of cash, though, so additional capital returns to shareholders and/or acquisitions cannot be ruled out.

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Linear Technology's Opportunities, And Challenges, Remain The Same

Seeking Alpha: Microsemi Puts Cash To Work In M&A And Buybacks

Back on July 25, I predicted that Microsemi (NASDAQ:MSCC) would likely stay active in the M&A arena and less than two months later the company has delivered - announcing the acquisition of Centellax. Microsemi also took the opportunity to introduce a new share buyback program and to confirm its fourth quarter growth guidance. Although none of these announcements meaningfully change the near-term picture for Microsemi, they're the sort of incremental positive moves that I've come to expect from this company and the Centellax deal could follow in the footsteps of past deals like Actel that add meaningful value down the road.

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Microsemi Puts Cash To Work In M&A And Buybacks

Seeking Alpha: Healthy Auto And Industrial Markets Could Take Analog Devices A Little Further

Analog specialist Analog Devices (ADI) has been a middle-of-the-road performer over the past year. While the company's margins remain at or near the top of the charts, revenue growth has been relatively less impressive and the stock performance (up about 12% over the past year) is squarely in the middle of analog peers/rivals like Texas Instruments (TXN), Linear Technology (LLTC), Maxim Integrated (MXIM), and ON Semiconductor (ONNN).

I'm not looking for Analog Devices to be a huge outperformer from here. The company's decision to steer 80% of free cash flow to shareholders won't hurt, and neither will the company's strong position in industrial and auto markets nor its leverage to China's LTE rollout. My discounted cash flow model doesn't suggest all that much long-term undervaluation today, though the company's margins do argue for a fair value closer to the mid-$50s.

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Healthy Auto And Industrial Markets Could Take Analog Devices A Little Further

Seeking Alpha: Maxim Has Room To Run A Little Further, But Long-Term Concerns Remain

The market is telegraphing quite a bit of optimism about the chip sector for the start of 2014. Better demand from industrial and auto customers ought to help, as should a comms market driven by China's 4G rollout. As Maxim (MXIM) has exposure to all of those markets, this could be a good first half of the year for this analog chip company and the company's valuation looks a little low relative to its peer group. This may be more of a date than a long-term commitment, though, as the company's outsized exposure to Samsung and high-end smartphones are still causes for concern.

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Maxim Has Room To Run A Little Further, But Long-Term Concerns Remain

The Motley Fool: Linear Technology: Love the Story, But Not the Price

You can fill a lot of pages with what is right about Linear Technology (NASDAQ: LLTC  ) . Not only is Linear among the leaders in the analog chip space, but it has a long history of excellent profitability. In fact, profitability is so important to the company that it let go of Apple's business when the margins no longer met management's standards.


Looking ahead, there's real growth potential for Linear in the industrial and auto markets in the coming years. Linear isn't the only company prioritizing these markets, as ON Semiconductor Analog Devices, and Texas Instruments are there too, but the potential of grabbing a larger share of auto OEM content and leveraging the Dust acquisition in factory automation is compelling. Alas, the price is not so compelling and investors need to really be sure that Linear is going to continue topping estimates for the stock to work at this price level.
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Linear Technology: Love the Story, But Not the Price

Seeking Alpha: ON Semiconductor Catching Bids On Improving 2014 Sentiment

There have been multiple false dawns in the chip sector, but it looks like investors are positioning themselves for a better 2014. ON Semiconductor (ONNN) is benefiting from that trend, as the shares are up about one-quarter from November and have beaten both the S&P 500 and Nasdaq since I wrote favorably on the shares in mid-August.

Multiple things should go right for the company in 2014, as weaker markets like computing should be close to stabilizing and the company leverages opportunities to go up-market in industrial, communications, and autos. ON Semiconductor's efforts to fix the problem-child that is SANYO should also start to pay off in a more meaningful way. Clearly there are a lot of "shoulds" there, but I believe ONNN shares are still worth something more on the order of $10 today.

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ON Semiconductor Catching Bids On Improving 2014 Sentiment

Investopedia: Analog Devices' Slow Walk To Better Days

The still-awaited semiconductor recovery is certainly taking its sweet time in getting here. In the meantime, Analog Devices (NYSE:ADI), one of the leaders in the analog space, remains in something of a holding pattern. Although the stock has done pretty well as investors look forward to better utilization driving higher margins and larger cash returns to shareholders, the business is still waiting to see sustained demand improvement in its end markets.

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Seeking Alpha: ON Semiconductor - If It Stops Getting Worse, It Could Get So Much Better

In Hollywood, asking "How can it get any worse?" aloud is a sure way to get either a comedic or horrific answer in the next scene. In the case of large chip maker ON Semiconductor (ONNN), a lot of things have gone wrong over the past couple of years. In addition to a deal for SANYO Semiconductor ("Sanyo") that just keeps looking worse and worse, ONNN has been hit by both the general slowdown in chip demand and the particularly weak conditions in computing and consumer electronics.

With all of the bad news and adverse developments, it's easy to overlook some positives that could start working in the company's favor and relatively soon at that. ONNN is a top four/top five player in multiple large markets (transistors, diodes, analog), and the company is actively working to move up the value chain. Given the company's low utilization rate and stabilizing Sanyo performance, the company would seem to have significant margin leverage potential - potential that generate free cash flow growth way ahead of revenue growth and support a fair value of $10 or higher.

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ON Semiconductor - If It Stops Getting Worse, It Could Get So Much Better

Investopedia: Texas Instruments Just Out Of The Starting Blocks

I'm not going to say that every part of the semiconductor space is back on track, but the earnings and guidance that coming suggests that things are getting better outside of consumer electronics and PCs. That's good news for Texas Instruments (NYSE:TXN), particularly as the company is seeing stronger conditions in industrial and auto markets and better margins in the wake of moving on from wireless. Although the stock does not look cheap on a cash flow basis, I do believe the company's margin leverage, and subsequent improvements in ROE, are likely to send the shares higher over the next 12 to 24 months.

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