It is no secret that the Street is hot on technology. From surging innovation in the consumer segment (tablets, laptops, television) to competitive services in the business outsourcing segment, the upside story has provided numerous opportunities and meaningful value investments. One great way to gain exposure to the broader industry is to back semiconductors, which supply virtually all technological end markets.
In this article, I review the fundamentals of Texas Instruments Inc. (TXN), Analog Devices Inc. (ADI) and Maxim Integrated Products, Inc. (MXIM). While some firms are meaningfully undervalued to growth prospects, like Analog Devices, others provide more of a defensive investment, like TI.
TI currently trades at a respective 18.1x and 12.1x past and forward earnings. It has a leading moat in the semiconductor field, but this has been more than factored into the stock given that the PEG ratio is more than 2. Analysts expect 9% annual EPS growth over the next five years and rate the stock a "hold," according to FINVIZ.com.
The company is one of the safest semiconductor investments due to its low debt levels, proven operational history and broad diversification. Early signs of improving end markets in communications will make up for a weak computing market. Moreover, in the long-term, I believe that both markets will re-excite back investors. Penetration in wireless will come with slightly lower margins as competition remains intense for design wins.
I am optimistic about the revenue and cost synergies that will arise from the integration of National Semiconductor, which was bought out for $6.5B in cash. The target already yielded more than one-fifth of its takeover price. A relatively strong financial position with $2.9B in liquidity will further act as a buffer for macro uncertainty.
When it comes to liquidity, there is perhaps no better semiconductor investment than Analog Devices. The firm has an incredible quick ratio of 7.6x, which indicates assets are not tied up in inventories. At the same time, the PEG ratio is lower than TI's and the multiples are fairly in-line with the broader market's. 10.7% annual EPS growth is expected over the next five years, which is more than 400 bps below what was yielded over the past five years.
Assuming consensus expectations are met and the company trades at a 15x multiple, the future stock value in 2016 will be $53.76. Discounting backwards by 10% yields a present value of $33.38. This will put downward pressure on the multiples, especially if macro trends do no improve. Job growth was 20% lower than economist forecasts in the recent monthly report and any signs of a marked turnaround would yield meaningful appreciation.
Management also remains committed to returning free cash flow to shareholders with its dividend yield of 3.2%. Solid results were experienced in the first quarter with a sequential 4% increase in the top-line and a 15% sequential increase in diluted EPS. Factory utilization trends will further expand margins and thereby help unlock value. Despite impressive growth, the stock has fallen slightly over the past three months.
Maxim Integrated Products
Maxim is currently the priciest and, in my view, the riskiest semiconductor firm out there. It trades at a respective 20.9x and 14.1x past and forward earnings for slightly higher growth forecasts. Future growth that beats giants like TI is also not to be taken for granted, hence I expect unusually high volatility for Maxim over the next few years. According to data sourced from FINVIZ.com, the stock has a beta of 1.14 and a "hold" rating on the Street.
I believe the semiconductor producer is well positioned to outperform in the second half of 2012 with limited PC exposure and sequential growth in the industrial, consumer and communication segments. The successful litigation against Samsung's tablet puts a bit of wet blanket on future momentum, but Maxim still has multiple value levers it can now allocate more resources towards.
Moreover, the company has demonstrated catalysts in smartphones. Samsung Galaxy S III has revealed traction yet again and may alone add $70M over the near-term. Many view this segment as a drag on margins, but checks by Caris & Co. have revealed that margins are at the high-end of 50-60% due to outsourced 300mm manufacturing.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.