Backed by strong dividend yields, semiconductors are both an attractive and safe way to diversify across technology. Investors appear to have recognized much of the upside and, accordingly, expanded multiples. The good news is that tech can be still be a solid growth investment and outperform the market if the macroeconomy trends better than expected. In my view, this bullish thesis justifies broad investment across firms, like Texas Instruments (TXN), Maxim Integrated (MXIM), Analog Devices (ADI). Below, I review the fundamentals of each company.
TI is one of the most well-regarded names in the field and is still forecasted for high single-digit growth in the next five years. It trades at a respective 20.2x and 12.9x past and forward earnings with a comparatively low dividend yield of 2.5%. The company is currently at a 25% premium to its historical 5-year average PE multiple; but, then again, annual growth over these next 5 years are expected to be more than triple what it was over the past 5. Combined with double-digit ROE and ROI, this makes TI an investment worth considering.
Going forward, management will be focusing on higher margin segments, like analog and embedded chips. I believe that this shift will be successful, since TI (1) has a powerful brand that it can leverage and (2) the acquisition of National Semi was a fundamental game changer. As for (1), the firm has been able to realize substantial design wins with its smartphone and tablet processors. As for (2), new advanced manufacturing equipment can now drive higher returns to capital.
The firm has also taken the proper steps to divest assets that limit the differential between ROIC and WACC - the source of value creation. By exiting the wireless baseband chip, TI has set itself onto a path of higher operating margins. During the second quarter earnings call, management released decent results and give a slightly disappointing outlook for the third quarter. Revenue of $3.3B (down 7% sequentially) was nominally below the midpoint of revised guidance. The flagship analog segment was up 7% sequentially as macro uncertainty led to inventory reductions. I nevertheless expect chip demand to recover as end markets improve from a nearing full recovery.
Maxim shareholders have been in for a wild ride over the last three months. The stock fell from around $29.75 to nearly $24 by the end of June and then went up and down to $27.17. Despite a weaker brand image than TI, the firm trades at a premium with a PE multiple of 22.1x. 13.7% annual growth is nevertheless forecasted over the next 5 years and supported by a high 3.5% dividend yield.
During the third quarter, Maxim beat earnings expectations off of strong gross margins. 3Q guidance for revenues was disappointing, but 3Q guidance for earnings was positive. To weather the downturn, management is expected to be generous with dividends. Design wins for smartphones and tablets, auto strength, and accretive M&A with Phyworks and Teridan continue to look attractive.
I am also optimistic about the company's future demand given the 300mm ramp and focus on distribution. This will help boost ROIC and margins in the long-term as demand picks up. With the company outperforming on the top-line and attractive enough to ride the product waves of Apple and Samsung, future growth is both sustainable and substantial. A consistent focus on 300mm and accretive M&A will likely drive outperformance in the years ahead.
Analog trades fairly expensive at a respective 17.1x and 15x past and forward earnings. Growth is forecasted for 10.7% annually over the next five years, which, in my view, is not strong enough to justify a greater investment over TI. The dividend yield of 3.1% is slightly higher and liquidity is excellent, but the PEG ratio stands at 1.59, which implies future growth has been more than factored into the stock price.
Assuming that the firm is able to achieve the forecasted growth, it will reach a valuation of $57.12 at a 16x multiple by 2016. Discounting backwards by 10% yields a present value of $35.47 - slightly below the current $39.35 per share valuation. Thus, while the margin of safety is not strong on the stock, growth is nevertheless decent when combined with the dividend yield. It's not as great as TI and Maxim's upside, but it is a worthwhile investment to diversify in.
During the second quarter earnings quarter, revenues grew 4% sequentially but were down 15% from the year-ago quarter. The latter - when inventories were high due to supply-chain disruptions - was a tough quarter. This recent quarter, industrial end markets were particularly strong and grew 12% sequentially with all major application areas took off. With networks overloaded by data and stressed by higher bandwidth requirements, the demand for equipment upgrades is growing. Under such a context, Analog has favorable secular trends to appreciate in value.