Why Avago Technologies Stock Is A Good Investment Opportunity

Aug.19.14 | About: Broadcom Limited (AVGO)

Summary

Avago's stock still has plenty of room to move up.

Avago has compelling valuation metrics and very strong earnings growth prospects.

Avago's stock is ranked first among all S&P 500 tech stocks, according to Portfolio123's "All-Stars: O'Neil" powerful ranking system.

Avago Technologies' (NASDAQ:AVGO) stock has surged strongly since mid-2013. In fact, its relative strength index (RSI) technical indicator is indicating almost overbought conditions. Since May 1, 2013, AVGO's stock has gained an astounding 139%. Nevertheless, in my opinion, AVGO's stock still has plenty of room to move up, because it has compelling valuation metrics and very strong earnings growth prospects. Furthermore, Avago has no debt at all, and it is generating strong cash flows that enables the company to make important acquisitions.

The Company

Avago Technologies is a leading designer, developer and global supplier of a broad range of analog, digital, mixed signal and optoelectronics components and subsystems, with a focus on III-V compound semiconductor design and processing. The company was founded in 2005, and is based in Singapore.

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Source: Company Overview August 2014

Valuation Metrics

The table below presents the valuation metrics of AVGO; the data were taken from Yahoo Finance and finviz.com.

Avago's valuation metrics are excellent; the company has no debt at all, its forward P/E is low at 14.19, and the average annual earnings growth estimates for the next five years is extremely high at 27.84%. Moreover, Avago's PEG ratio of 0.67 is exceptionally low. The PEG Ratio - price/earnings-to-growth ratio - is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.

Latest-Quarter Results

On May 29, Avago reported its second-quarter fiscal year 2014 financial results, which beat EPS expectations by $0.09 (11.80%), and beat the Street's estimates on revenues.

Net revenue was $701 million, a decrease of one percent compared with the previous quarter, and an increase of 25 percent from the same quarter last year.

Net income (Non-GAAP) was $223 million, or $0.85 per diluted share. This compares with net income of $217 million, or $0.84 per diluted share last quarter, and net income of $153 million, or $0.61 per diluted share, in the same quarter last year.

In the report, Hock Tan, president and CEO of Avago Technologies, said:

In the second fiscal quarter of the year, our wireless business came in significantly above our expectations due to strong product ramps for our FBAR-related products into multiple Asian Smartphone OEMs. We also saw a resurgence in Industrial re-sales through our distributors, especially in Europe and Japan. The third quarter marks a transformative event in Avago's history as we completed the acquisition of LSI, creating a substantially larger company with a much more diversified and balanced mix of end markets.

Next-Quarter Results

Avago will report its third-quarter fiscal year 2014 financial results on August 28. AVGO is expected to post a profit of $1.04 a share, a 40.5% rise from the company's actual earnings for the same quarter a year ago.

Dividend

Avago has been paying uninterrupted dividends since December 2010. The forward annual dividend yield is at 1.55%, and the payout ratio is at 39.5%.

Avago has raised its dividend payment every quarter. Since the company generates lots of cash, has no debt and the payout ratio is low, there is a good chance that the company will continue to raise its dividend payment.

AVGO Dividend Chart

AVGO Dividend data by YCharts

Competitors and Group Comparison

A comparison of key fundamental data between Avago and its main competitors is shown in the table below.

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Avago has the highest earnings growth prospects among the stocks in the group, and the second-highest dividend yield. However, its EV/EBITDA ratio at 20.08 is higher than those of its competitors.

Avago's Margins and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median, as shown in the tables below.

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Source: Portfolio123

Ranking

According to Portfolio123's "All-Stars: O'Neil" powerful ranking system, AVGO's stock is ranked first among all S&P 500 tech stocks. The ranking system is based on investing principles of the well-known investor William O'Neil. The "All-Stars: O'Neil" ranking system is quite complex, and it is taking into account many factors like; EPS Growth, Sales Growth, Industry Growth, Market Conditions and Margins, as shown in the Portfolio123's chart below.

Back-testing over fifteen years has proved that this ranking system is very useful.

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The AVGO stock price is 4.44% above its 20-day simple moving average, 3.86% above its 50-day simple moving average and 23.51% above its 200-day simple moving average. That indicates a strong uptrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is negative at -0.54 and ascending, which is a neutral signal (a rising MACD histogram that is crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 67.92, approaching overbought conditions.

Analyst Opinion

Many analysts are covering the stock, and most of them recommend it. Among the twenty-four analysts, five rate it as a Strong Buy, fourteen rate it as a Buy, and five rate it as a Hold.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering AVGO stock, there are eleven analysts who have the four or five-star rating, nine of them recommend the stock and the other two top analysts rate it as a Hold.

Major Developments

On August 13, Avago and Intel announced the signing of a definitive agreement for Intel to acquire LSI's Axxia Networking Business and related assets for $650 million in cash. The transaction, which has been approved by the boards of directors of both Avago and Intel, is expected to close in the fourth calendar quarter of 2014 upon satisfaction of government approvals and customary closing conditions. LSI's Axxia Networking Business is being divested from Avago following the recent completion of Avago's acquisition of LSI. The Axxia Networking Business generated revenues of $113 million in calendar 2013, and employs approximately 650 people.

On June 23, Avago and PLX Technology, Inc. (NASDAQ:PLXT) announced that they have entered into a definitive agreement under which Avago will acquire PLX, a leader in PCI Express silicon and software connectivity solutions, in an all-cash transaction valued at approximately $309 million, or $293 million net of cash and debt acquired. Under the terms of the agreement, which was approved by the boards of directors of both companies, a subsidiary of Avago will commence a tender offer for all of the outstanding shares of PLX common stock for $6.50 per share in cash. Avago expects to fund the transaction with cash available on its balance sheet. On August 12, Avago announced that it has completed the tender offer.

On May 6, Avago and LSI Corporation announced that Avago has completed its acquisition of LSI Corporation for $11.15 per share in an all-cash transaction valued at approximately $6.6 billion. The acquisition creates a highly diversified semiconductor market leader with approximately $5 billion in projected annual revenues.

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Source: Avago Technologies To Acquire LSI Corporation

Avago's strong balance sheet (current ratio at 4.90, and quick ratio at 4.20) enabled the company to make important acquisitions. I consider the acquisition of LSI very positive for Avago, since the two companies offer complementary products. Avago believes that the acquisition of LSI positions it as a leader in the enterprise storage market. The acquisition also expands Avago's product offerings and brings system-level expertise in its wired infrastructure market. According to Avago, with increased scale and a diversified product portfolio across multiple attractive end-markets, the combined company is strongly positioned to capitalize on the growing opportunities created by the rapid growth in data center IP and mobile data traffic.

Avago has been able to show an earnings per share surprise in each one of the last four quarters, as shown in the table below.

Data: Yahoo Finance - Analyst Estimates

In my opinion, the fact that the company succeeds to beat analyst expectations quarter after quarter demonstrates the strength of its business, and there is a good chance that Avago will continue to surprise by reporting better-than-estimated results also in the future.

AVGO's stock started its rally in May 2013, and continued to performed very well in 2014. Since the start of the year, AVGO's stock has gained 41.4%, while the S&P 500 index has risen 5.8% and the Nasdaq Composite Index has increased 6.9%. Moreover, since the beginning of 2013, AVGO's stock has recorded an astounding gain of 136.3%, while the S&P 500 index has increased 37.1% and the Nasdaq Composite Index has risen 47.9%. Nevertheless, considering its excellent valuation metrics and strong earnings growth prospects, the stock, in my opinion, has plenty of room to move up.

Conclusion

Avago has excellent valuation metrics and very strong earnings growth prospects; its PEG ratio is very low at 0.67. Moreover, AVGO's stock is ranked first among all S&P 500 tech stocks, according to Portfolio123's "All-Stars: O'Neil" powerful ranking system. Furthermore, Avago has no debt at all, and it is generating strong cash flows that enables the company to make important acquisitions.

All these factors bring me to the conclusion that AVGO stock is a smart long-term investment. Furthermore, the growing dividend represents a gratifying income.

Disclosure: The author is long AVGO.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.