Why Skyworks Solutions Looks Set For A Good Run

Summary

• Skyworks shares have enjoyed a great run over the last five years.
• While there are risks, the rally is backed by solid fundamentals.
• The opportunities ahead make Skyworks a compelling investment option.

Shares of Skyworks Solutions (NASDAQ:NASDAQ:SWKS) have delivered an eye-popping 252% return over the last five years, implying that investments in the stock have swelled 3.5 times in value. Often, returns as massive as these can dissuade investors from initiating fresh positions. However, Skyworks is one of those businesses that have backed superior returns with a strong performance. The company's financials across the board justify the returns that investors have enjoyed. And though the stock currently trades at seemingly pricey valuations, it looks set for a good run in the medium to long term.

Numbers And Fundamentals

If you look at Skyworks' financials over the preceding five years, the numbers are quite impressive. Consider the latest quarter March ending and compare that with the same quarter in 2012. Skyworks' revenues have multiplied 2.3 times over this time period. What's really been most impressive, though, is how margins have expanded across the board, especially at an operating level. While gross margins have expanded from 42% back then to 50% in March this year, operating margins have expanded from 12% to 33%, and net margins have swelled from 9% to 26%. All of this has resulted in massive growth in profits.

While gross profits have multiplied 2.8 times, operating margins have increased 6.4X and net profits have increased 6.6 times. It's worth noting that the pace at which profits have grown has clearly outpaced the rate of growth in valuations so far. Looking beyond the top and bottom line numbers further bolsters faith in this narrative. There's very little debt on the books, and cash flows have grown at a good clip too. While operating cash flow (OCF) has increased 2.8X between FY 2012 (Sep ended) and FY 2016, free cash flows have increased 4.7 times. OCF, which stood at 1.1 times net income for FY 2016, stands at 1.5 times net income for the latest six months. Similarly, the FCF margins, which came in at 28% for FY ended September 2016, have risen to 35% during the first half of the fiscal year 2017 (March ending). The company has managed to generate a return on equity (ROE) of 25%, and a return on invested capital of 37% over the last 12 months. And while you're holding onto the shares, the prospects of pocketing dividend income look good too.

Given the kind of capital appreciation investors have seen, a 1.2% dividend yield isn't bad at all. What's more, Skyworks' dividends payouts have been increasing rapidly, and there's scope for further growth. The company's payouts increased by 195% YoY in FY 2015, and 63% in FY 2016. And if you annualize the payout so far this year, payouts could amount to $1.12 a share, compared to $1.06 last year. That's a 6% hike in dividends. Given that the payout ratio is still relatively low at about 20%, and the company's sustainable growth rate of just under 20%, there's scope to increase payouts. Dividends cost the company just over $200 million last fiscal, compared to free cash flows of over $900 million.

A Look At The Key Risks

One of the risks that investors should factor in stems from valuations that are on the higher side. At 5.1 times Trailing 12 Month (TTM) sales, the stock seems expensive. However, this could be justified partially by the rate of profit growth. If you look at the PE multiple, valuations aren't all that pricey at 19.2 times TTM earnings. On a forward basis, things look even better. Yet, given the kind of run the stock has seen, with over 20% gains in the Year To Date (YTD), a disappointment in the coming quarters could lead to a correction.

The second and more important risk emanates from Skyworks' dependence on Apple (AAPL), with as much as 44% of its revenues coming from the latter in FY 2015. Apple's contribution to the company's top line has reduced, coming in at less than 40% in the latest quarter. Skyworks is also working to diversify its revenue sources, and curb its dependence on Apple. However, there's no doubt that this risk still persists, for now at least. So, if Apple's iPhones do badly this year, Skyworks is likely to feel the pain as well.

Beyond Financials - What Skyworks Has Going For It

There have been some contrary opinions lately about the prospects of Apple's upcoming iPhone model. While some opine that we are on the brink of a supercycle, others think expectations are too high. However, not many expect the model to bomb, and reasonable sales should come through, given the hype and expectations surrounding Apple's 10th anniversary iPhone model. And this will help Skyworks. As we mentioned earlier, the latter also is diversifying its sources of revenue and has seen growing adoption among Chinese smartphone makers.

One of those is Huawei, which accounted for over 10% of its revenue last quarter. Huawei's shipments grew by close to 30% in 2016, as it expanded further into overseas markets and held fort in its domestic market. Sales numbers are expected to remain strong, and Skyworks' dollar content, which is the dollar value of chips placed inside each smartphone, is growing. Put together, this trend should aid Skyworks' growth in the coming quarters, and cushion the weakness, if any, which could stem from weak iPhone sales.

In the case of Huawei, the company expects that its dollar content is approaching $10 per unit. This is encouraging because, about a year and a half ago, Skyworks reported that it had a content share of $1 to $2 per 3G device, more than $3 per 4G device, and over $5 per advanced 4G device. Dollar content growth is a broader trend that's going to be pervasive across smartphone makers. With every generation of wireless networks, RF content in smartphones is increasing, and this trend is likely to continue. For instance, reports suggest that the iPhone 7's RF content rose by 17% over the previous generation to $19 per unit. Skyworks has been one of the beneficiaries, along with Broadcom (AVGO) and Qorvo (QRVO).

Quoting from the report, "Qorvo's research points out that a 4G smartphone contains 400% more RF content as compared with a 3G smartphone, thanks to the higher number of frequency bands." With the imminent launch of 5G networks in the coming years, Qorvo expects smartphone RF content to grow at 15% annually.

While that takes care of the prospects in its traditional business, Skyworks also is foraying into burgeoning futuristic spaces, targeting IoT devices such as wearables and action cameras and automotive solutions. Apart from Volkswagen, Skyworks’ products will also find their way into cars made by a U.S. based electric car maker, which it hasn’t named. With estimates pegging the number of connected devices at 25 billion by 2020, the opportunity is huge. If Skyworks can successfully transition into a play on IoT and automotive solutions, the market could value this company differently, potentially driving the stock price further.

Technicals

At the moment, Skyworks' technical charts still look a bit weak. The stock has fallen below its long-term support, the 20 day Simple Moving Average and also breached long-term SMAs like the 50-day and 100-day SMAs. The 20-day SMA recently breached the 50-day SMA, which is a bearish signal, and the next level of support comes from the 200-day SMA, at $89.11, which is about 7% lower than yesterday’s closing price of $95.3. However, whether you look a the Bollinger Bands or the Relative Strength Index (RSI), the stock is slowly approaching oversold territory. A further decline could serve as an opportunity to accumulate shares. To ensure a safer, more conservative approach, investors could look to buy on dips.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

This article was written by Vikram Nagarkar, an equity analyst at Amigobulls. Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

Comments

[Nevin_S]

From EE Times June 22, 2017

Handsets Expected to be Largest Market for ICs
Dylan McGrath

AUSTIN, Texas — Sales of chips for cellular handsets will surpass sales of chips for PCs for the first tine in 2017 as the PC sales slump continues and tablet shipments also plummet, according to market research firm IC Insights Inc.

Sales of ICs for handsets are projected to grow 16 percent this year to reach $84.4 billion, according to IC Insights. Meanwhile, sales of ICs for PCs—including desktop and notebook computers, tablets and ultra-thin Internet-centric client devices—are forecast to grow 9 percent to reach $80.1 billion, the firm predicts.

Booming memory chip prices will boost growth in both phones and PCs, IC Insights said. But by virtue of the higher growth rate, handsets will become the largest application for ICs this year for the first time, according to the firm.

[vanquish0927]

Huawei, one of swks' client, is growing rapidly in Asia and worldwide, the reliance of swks on apple will reduce significantly which is a good sign. Not to mention Samsung is another client of swks, too.

[MrCook]

Skyworks' net profit in the last 4 quarters was $914.5 M, or 27.27%, which is 154% higher than the 12.76 % average profit margin in the Semiconductor industry. Marketgrader calculates the company's optimum P/E at 29.00 based on the company's annualized growth rate over the last five years, which makes the stock look cheap at current valuations. It's interesting to me that Apple has so much control over SWKS future, yet it doesn't exert more pressure on its prices. Do other companies offer the same type of semiconductors as Skyworks or is their product protected by a wide moat? To me that seems to be the most important factor unless SWKS expands its market. I don't know the answer, but I hope someone can tell me. Thank you.

[Philip Marlowe]

There are other companies that purport to do the same thing skyworks is doing but I think Skyworks has a rather large moat.

The thing about the products skyworks is making is that quality and performance of the product is of paramount importance and the performance characteristics of their chips are complex and are not usually discussed in public filings.

But clients definitely know how to measure performance and keep choosing skyworks. So in general I think skyworks' ever climbing revenues combined with their ever climbing gross margins in a business that is notorious for price competition and margin squeezing by powerful clients are the best evidence that skyworks has a significant competitive advantage.

And that is also why Apple doesn't exert more pressure on prices. There are no competitors able to deliver the same performance for those chips.

SWKS has a couple of competitors. One of them -- AVGO, is known for making very high quality filters, but Broadcom is quite content to stay in their corner of the market (the very expensive and high margin BAW filters) and let SWKS have everything else. Another competitor is QRVO, but if you look at their financial performance, it is clear that QRVO's chips are not as good as SWKS's. This is confirmed if you look at design wins -- QRVO keeps winning the cheap 3G chips on price while SWKS wins the high spec 4G chips.

Probably the scariest competitor right now is Qualcom. Qualcom has been trying to muscle in on SWKS turf now for several years. But they have not managed any significant success yet. Qualcom is very good in the digital parts of cell phones, but analog is very different than digital, and it is also very difficult. So I would not fear Qualcom unless they show more success.

Overall, I would say that SWKS moat is very good.

[Philip Marlowe]

In addition, regarding P/E ratios, I think for a company that is followed by many reputable analysts, the forward P/E is a better way to judge valuation. SWKS forward P/E is 13.5, so it is still rather cheap for a leading semiconductor company growing at 10% per year.

Of course if the new iphone is a hit as everyone expects it to be growth should accelerate pretty soon. In the medium turn, the switch to 5G should improve growth.