NXP Semiconductors: No Stretched Bargain Here

| About: NXP Semiconductors (NXPI)

Summary

Despite the recent rally, NXP only trades at the same levels as prior to the announcement of the deal to purchase Freescale Semi.

The market is starting to show signs of improvements from the year-end inventory correction and slowdown.

The synergy benefits from the Freescale deal make the stock a strong recommendation at the current price around $80.

For the first time in months, the semiconductor market is starting to see some daylight from the funk that transcended onto the sector during Q3. Stretched lead times for both NXP Semiconductors (NASDAQ:NXPI) and Broadcom Limited (NASDAQ:AVGO) are early indications that the inventory correction in the sector that started in October has reached a bottom.

Source: NXP Semi website

Not surprising, NXP Semi hit a bottom around early February when the inventory correction was coming to an end and the stock market rebounded. Even after the recent big rally, the stock trades at only $83 and far from the highs after announcing the Freescale deal and huge benefits that came along with the deal.

The good question is whether any reason exists to not go along with the $120 price target from Canaccord?

Market Improvements

Though the semi market had some general weakness at the end of last year, the biggest issue was an inventory correction. NXP Semi and other semi suppliers ended Q3 with inventory levels too high at distributors. To that regard, the company saw Q4 sales into the distribution channel down 22% while sales out of the channel were down only 5%. The end result was that channel inventory was cleaner to start 2016.

The bullish lead time news from FBR analyst Christopher Rolland is a crucial sign that the inventory correction hit the bottom already. The analyst suggests that lead times to fill orders for both NXP Semi and Broadcom are lengthening as orders are likely picking up. The Freescale business saw a four-day boost MoM, but the NXP side is still falling though stabilizing.

The new NXP Semi remains primly positioned with the addition of Freescale to dominate the connected car world. At the same time, the NFC business is only growing as we've seen signs of strong demand for Apple (NASDAQ:AAPL) Pay in China and agreements with Qualcomm (NASDAQ:QCOM) and Xiaomi for mobile payment solutions.

Xiaomi recently released the Mi 5 with the secure element and NFC chip solution from NXP, and Apple announced a cheaper version of the iPhone that introduces the mobile payment solution to more lower-end customers. The Mi 5 has racked up 16.5 million pre-orders already and gets solid reviews from sites like Mashable. Due a lower price point, even lower than the new iPhone SE, Xiaomi has a chance to eventually catch and surpass Apple on volumes.

Don't Forget Freescale

The company remains on target for $200 million of synergies in 2016 and $500 million by 2017. The amounts are significant considering NXP Semi only has 354 million shares outstanding amounting to a $1.41 EPS boost by 2017.

The inventory correction from last year's adjusted expected numbers going forward might be the wrong assumption to make. Analysts forecast nearly flat EPS growth in 2016 despite the immediate $0.50 per share synergies of the accretive merger this year. This doesn't even include some of the upside from borrowing low-cost debt to finance the deal.

With NXP Semi earning $5.60 in 2015, keeping the business producing stable profits would cause the EPS to soar beyond $6 this year with the synergies. If the inventory correction ends and the semiconductor market rebounds to previous expectations, the realistic targets for the new NXP were previously set at $9.50 per share in 2017 and $11.00 in 2018.

Regardless, NXP Semi will throw off well over $1 billion in free cash flow that the company will use to initially pay down debt and eventually repurchase shares if the stock trades this low.

Takeaway

The analyst target of $120 from Canaccord appears right on target. The new NXP Semi is solidly positioned in growth markets and attractively priced based on realistic expectations that earnings will soar far above current targets whether the original merger numbers are achieved.

NXP Semi remains a strong recommendation to buy at the current levels and on any future dips.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NXPI over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.