Great news for NXP Semiconductors (NASDAQ:NXPI) this week. According to the Financial Times, NXP Semiconductors will supply Apple (NASDAQ:AAPL) with Near Field Communications chips to support a new mobile payment solution for the new iPhone 6. NXP's NFC chips can connect two devices when brought close together. Further, NFC is unique in the way it uses energy. Only one of the two devices need to be powered to establish a connection (source: nxp.com).
Apple is likely to introduce the new iPhone 6 during the upcoming Sept. 9 event. The first shipments for the iPhone 6 are expected within two weeks after the event. This is great news for NXP because the launch should be one of Apple's most successful product launches ever. Large demand for NFC chips from Apple will boost NXP's Q3 and Q4 revenue and earnings.
NXP needed this success for its "Identification" division because this division was the worst performing division in terms of revenue growth in the second quarter of 2014. According to the company's Q2 earnings report, revenue grew only 1% from $339 million in Q2 2013 to $343 million in Q2 2014. Now, with Apple's peak demand for NFC chips, it is likely that revenue growth will increase in the upcoming quarters.
From a business perspective, NXP Semiconductors is an attractive company. Recent developments are consistent with my previous analyses of this stock. I already expected increasing demand for mobile solutions in January of this year. Since my article was published, the stock rallied from $43.50 on January 3, 2014, to $68.50 on August 29, 2014. This equals an impressive total return of 57.30%. Another potential catalyst for the stock is a recent article about consolidation in the semiconductor industry. According to FBR's Mr. Rolland, NXP is an M&A target for US chip makers.
However, investors should notice that NXP's valuation is becoming more and more stretched. There are several signals that indicate that the stock's impressive run (57.30% return year-to-date) could be running out of steam. For example, Goldman Sachs (NYSE:GS) recently turned cautious on chip makers and, as part of their industry downgrade, lowered its rating for NXP to Sell.
Another indicator for the company's stretched valuation is NXP's price/earnings ratio in relation to the industry's average price earnings ratio. NXP trades 33.50 times the company's earnings per share compared to an average of 22.70 for the Broad Line Semiconductor industry (source: biz.yahoo.com). This indicates the stock is overvalued compared to industry peers.
Apple's iPhone 6 launch is very positive for NXP because it is likely that Apple will introduce mobile payments supported by NXP's NFC chips. As a result, NXP's Identification division will be able to grow revenue at a much faster pace than over past quarters. NXP could also become an M&A target for US chip makers, according to several reports.
On the other hand, NXP had a nice run over the first eight months of this year. The stock is up 57.30% year-to-date. As a result, the company's current valuation (P/E ratio: 33.50 compared to 22.70 for industry peers) could become an obstacle for the stock to gain even more. Goldman Sachs more or less confirmed the stretched valuation as it downgraded NXP to sell this month.
Overall, I still believe that NXP Semiconductors is a very attractive company with good growth potential. However, investors should not ignore the company's current valuation.
Disclosure: The author is long AAPL.
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.