Semiconductors are an attractive way to diversify investment across technology due to how they, one way or another, supply all end markets. On the other hand, supply chain disruptions and fears over accounting methods have significantly discounted some producers. In this article, I will run you through a DCF model on one such firm, Marvell (MRVL), that has been irrationally discounted below intrinsic value. After finding the firm's fair value, I will then compare there result to the fundamentals of Broadcom (BRCM) and Texas Instruments (TXN).
First, let's begin with an assumption about the top-line. Marvell finished FY2012 with $3.4B in revenue, which represented a 6.1% decline from the preceding year. I model 14.1% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold eating 42% of revenue versus 8% for SG&A, 28% for R&D, and 3% for capex. Taxes are estimated at 5% to 10% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around 1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $26.34, implying that the stock will double. The market seems to be factoring in an irrational discount rate of 20%, which should only be applied to high-risk start-ups. Management's recent dividend hike should renew confidence in the fundamentals. It is also important to stress that my free cash flow figures hover around where they stood from FY2009 - FY2012.
All of this falls within the context of strong operating performance during the first quarter of FY2013:
"[W]e reported first quarter revenues of approximately $796 million, reflecting a 7% sequential increase from the prior quarter and above the high end of our previously projected range. The reason for the better-than-expected revenue performance was 25% sequential growth in our TD-SCDMA revenues and increased deployment by all of the drive customers for our leading -- industry leading 500 gigabyte per platters mobile HDD products.
This is in contrast to the overall revenues for our nearest competitor in the TD market, which declined double digits while our competitor in the storage space are not shipping similar 500-gigabyte technology".
From a multiples perspective, Marvell is also very cheap. It trades at 10.9x FY2012 free cash flow and also at a respective 13.9x and 8.6x past and forward earnings. This compares to corresponding figures of 22.4x and 9.8x for Broadcom and 18.5x and 12x for TI.
Consensus estimates forecast TI's EPS declining by 18.6% to $1.80 in 2012 and then growing by 32.8% and 18.8% in the following two years. Assuming a multiple of 17.5x, a deserved premium, and a conservative 2013 EPS of $2.36, the stock would hit $41.30. TI is a strong brand and a safer investment than Marvell. With a dividend yield of 2.2% on top of incredible upside, I highly recommend making an investment in this leading semiconductor.
Consensus estimates for Broadcom's EPS forecast that it will grow by 0.3% to $2.90 in 2012 and then by 10.7% and 8.4% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $3.18, the stock would hit $41.34. With the stock only offering a dividend yield of 1.1%, I recommend holding out until a full recovery materializes. If you are going to be backing technology companies, it is best to pick those that will deliver strong growth above what the market acknowledges. The bar has simply been set to high for Broadcom relative to TI and Marvell.
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