Goldman Sachs (GS) downgraded NXP Semiconductors (NXPI) on Thursday January 2, 2014. Goldman Sachs points at the current high valuation and expects that the cyclical growth will slow in 2014. Despite the downgrade, Goldman Sachs remains their $44 a share price target for the stock. As a result, the shares fell over 4% during Thursday's trading session. This article argues that today's decline is a perfect investment opportunity for this stock, because NXP Semiconductors is not overvalued compared to its main peers Dialog Semiconductor (OTC:DLGNF), Cirrus Logic (CRUS) and Skyworks Solutions (SWKS). Further, the market conditions remain favorable within the semiconductors industry.
NXP Semiconductors innovates, designs and manufactures high performance mixed-signal solutions for radio frequency, analog, power management, interface, security and digital processing. The company is headquartered in Eindhoven, the Netherlands. One of the company's most important customers is Apple (AAPL). NXP Semiconductors' main peers are Dialog Semiconductor, Cirrus Logic and Skyworks Solutions. More information at the corporate website: www.nxp.com.
Several favorable market conditions will support revenue and earnings growth for NXP Semiconductors in the future. First, the company will expand its automotive business in China (see this press release). NXP Semiconductors and Datang Telecom (SSE: 600198) will establish China's first automotive semiconductor company. This article provides an additional insight in NXP Semiconductors' growth potential in China.
Second, Dialog Semiconductor (one of NXP Semiconductors main competitors) reported better-than-expected market conditions in the fourth quarter of 2013. Therefore, Dialog Semiconductor increased its revenue outlook for the fourth quarter of 2013 from $270-295 million to at least $310 million. Although NXP Semiconductors did not increase their revenue outlook for the fourth quarter of 2013, Dialog's press release is an indication that the market conditions remain favorable.
The deal between Apple and China Mobile (CHL) is another positive development for NXP Semiconductors. Apple is an important customer for NXP Semiconductors. The deal between Apple and China Mobile will support demand for NXP Semiconductors' mobile solutions in the future. As a result, the company should be able to grow revenue and earnings-per-share in the upcoming years as well.
Wall Street Journal reporter Renee Schultes wrote this article about NXP Semiconductors on December 1, 2013. The article provides an insight in NXP Semiconductors' valuation compared to a diversified group of semiconductor peers. The article states:
NXP, which has a market value of almost $11 billion, is even cheaper relative to peers than it was a year ago. Its discount on a forward price-to-earnings basis to diversified semiconductor peers has widened from 10% at the end of last year to 25%. That is despite a 36% rise in sales over the past two years generating a 257% rise in earnings. The industry median is just 13% earnings growth on flat sales, according to Credit Suisse (CS).
According to the article in the Wall Street Journal, NXP Semiconductors is undervalued compared to a diversified group of semiconductor peers. Now, how about NXP Semiconductors' valuation compared to the peers Dialog Semiconductor, Cirrus Logic and Skyworks Solutions? These three peers are more comparable with NXP Semiconductors' business than a diversified group of industry peers. I present the data regarding the current market capitalization, share price, earnings-per-share and trailing P/E ratio in the table below.
* Market capitalization noted in billion USD
I find that NXP Semiconductors is not overvalued compared to its peers Dialog Semiconductors, Cirrus Logic and Skyworks Solutions. In fact, only Skyworks Solutions has a slightly lower trailing P/E ratio compared to NXP Semiconductors, based on this year's earnings-per-share. This supports my argument that NXP Semiconductors is not overvalued compared to its peers.
Although I am bullish about NXP Semiconductors, you should consider several risks. First, the company is more leveraged than its peers. The company's current debt-to-equity ratio is displayed in the graph below. As a result of the higher leverage, the company is more vulnerable to market fluctuations than its peers. However, the free cash flow is strong and still growing.
Second, the market conditions may not remain as favorable for NXP Semiconductors as they are now. Goldman Sachs named the slowing cyclical growth as one the two reasons to downgrade the stock from Buy to Neutral. However, this could be offset by an increase in demand for NXP Semiconductors' mobile solutions (following the deal between Apple and China Mobile) and the expansion of its automotive business in China.
Despite Goldman Sachs' downgrade, I consider NXP Semiconductors as a great stock to invest in. NXP Semiconductors will benefit from strong market conditions, the expansion of its automotive business in China and the increasing demand for its mobile solutions. The company is not overvalued compared to its main peers. In fact, only Skyworks Solutions' trailing P/E ratio is a little better than NXP Semiconductors' trailing P/E ratio. Therefore, I find the recent sell-off a perfect opportunity to add this stock to any portfolio.