Maxim Integrated: An Attractive Buyout Target
- Maxim Integrated stock has increased more than 36% over the last year since my last article on the company was published.
- The corporation achieved solid results in Q2 FY 2018, demonstrating 13% revenue growth year-over-year.
- Rumors suggest there is merger interest from certain companies, which is likely to drive the stock higher.
- The corporation is reasonably valued and pays decent dividends, which makes it attractive for investment.
The undercovered semiconductor corporation
Maxim Integrated Products (MXIM) is one of the semiconductor corporations that deliver strong results but still remain relatively undercovered. My last article on the company was written at the end of April 2017, and since then only three more articles were devoted to MXIM. At the same time, the stock has risen more than 36% over the last year, which beats the performance of the broad market and goes in-line with the return of the semiconductor index (SOXX) without accounting for dividends.
The YTD results are even more representative - the return for MXIM stock amounted to solid 16.5%, while the SOXX index increased by 7.2% and S&P 500 rose by only 0.3%.
Decent Q2 results, promising guidance provide boost for the stock
On January 25, Maxim reported its results for the quarter ended December 2017, beating on revenue. The growth in sales is accelerating at a rapid pace, which is likely to continue in the near future, according to the corporation's guidance.
Here is the history of MXIM's earnings over the last 13 quarters.
(Source: Seeking Alpha)
And here is how the growth trend looks like.
(Source: the author's calculations)
Revenue for the second quarter amounted to $623 million, up 13% from the same quarter a year ago. This was $2 million higher than expected by the analysts.
(Source: Earnings Slides)
The automotive continued to be one of the strongest segments of the company, as it was stated during the earnings call the division grew double-digits in December quarter. In my previous article, I stated that the automotive market was a catalyst for growth for MXIM, and it is clear that this continues to be true. The corporation clearly profits from the autonomous driving trend, and I expect this will boost MXIM's performance in the near future, as the number of companies entering the market with their own technology is increasing. Moreover, as the number of electric vehicles on the roads is going to grow rapidly due to several factors, including government legislation in European countries, Maxim's battery management solutions will likely be in high demand.
As we highlighted at the Consumer Electronics show, our relationship with Nvidia is alive and well. Maxim's leading-edge power management and serial link solutions continue to be part of Nvidia's next-generation autonomous driving platforms. In addition to our strong Nvidia partnership, we continue to sell automotive power and interface products attached to multiple partner platforms at many automotive customers.
Industrial segment was also "strongly up" in the quarter. Importantly, management claims industrial is the company's "core segment," and it is driven primarily by factory automation products. It is also stated the March quarter will be strong for this segment and the growth will be positive on a sequential basis and year-over-year.
The only revenue segment that decreased during the quarter was the consumer division, due to weak smartphone sales. It was reported in February smartphone sales recorded the first ever global decline in Q4 2017 - Gartner's figures indicated a 5.6% decline over Q4 2016 figures. However, Q1 2018 is expected to be better, since delayed sales boost is forecasted for Apple due to the return to "normal delivery cycle, while Samsung unpacked its successor Galaxy flagships. These facts likely also influence Maxim's expectations - the corporation guides the consumer segment to be strongly up for the March quarter.
The overall revenue segmentation for Q2 FY 2018 is presented by the picture below.
(Source of data: Q2 Earnings Call)
When it comes to financial performance, Maxim Integrated also looks solid. Its operating income soared more than 34% year-over-year in Q2 2018, driven by strong business and increasing margins. Hence, the company's operating margin increasing by more than 5 percentage points over the last year.
Moreover, Maxim's total cash position increased from $2.75 billion in June 2017 to $2.82 billion in December, while the total debt remained on the same level, which shows the increase was organic (based on operating performance). The spend on share repurchases and dividends also grew from last year and amounted to total $354 million for the six months ended December 2017. Importantly, the management seems to be more than confident over the future of its strategy of returning capital to shareholders - the company increased its quarterly dividends by 17% and also stated to increase stock repurchases going forward.
Given our confidence in the long-term prospects for the company's strategic position and increased access to our international cash provided by tax reform, I'm pleased to announce that we will now return 100% of free cash flow to shareholders.
The corporation seems to be an attractive M&A target
It was reported earlier this year Maxim Integrated became an acquisition target for Japanese automotive chipmaker Renesas Electronics Corp. The deal was claimed to be valued up to $20 billion, which would represent more than 20% premium over the market price before the announcement.
The merger talks were denied by both parties shortly after the news was made public. However, such rumors often have some basis in reality, so even if this merger will not be realized in the future (which is likely), some interest by other corporations may appear. The company clearly became much more expensive after its jump in the first two months of 2018, as strong earnings and guidance and merger interest are the factors that investors price in. However, the relative valuation still seems to be reasonable compared to some companies with similar market cap, such as Cavium (CAVM) or AMD (AMD), especially considering high growth rate, strong dividend policy, and ties with such booming corporations as Nvidia (NVDA).
MXIM stock is reasonably valued, but the margin of safety is low
To strengthen the analysis, I use discount cash flow model to value the company. I updated my model in light of Q2 2018 results.
My analysis is based on the following assumptions:
1. The average annual revenue growth over the horizon period of five years is estimated to be around 10%. The same revenue growth is expected for FY 2018, supported by the actual results for the first two quarters and by the management's expectations for Q3.
2. EBITDA margin will remain on the level of 35% over the horizon period.
3. The tax rate is estimated to be at the level of 14%, which is taken from the latest earnings call.
4. Then goes the WACC.
The after-tax cost of debt is 1.8%. The cost of equity capital (13.1%) is calculated using CAPM, with 1.13 beta, 2.9% risk-free rate, which is the current U.S. 10-year bond yield, and 9% market premium. The WACC is, therefore, estimated to be 12.2%.
Here is the operating and balance sheet data used in the modeling:
As a result, the model shows $16.8 billion equity value under the base scenario, which assumes EV/EBITDA multiple will be at the level of 15 by the end of the horizon period (FY 2022). This level of the multiple is conservative considering current market conditions. In this case, the fair value of the stock is $59.7.
The sensitivity analysis shows a range of possible outcomes that will be driven by actual results of the corporation. In light of this, the fair price range is $58.3-61.2, which represent the current price level. At the same time, it should be noted here that this analysis does not take into account the share repurchases program, which should "artificially" drive the stock price higher as the number of shares outstanding is going to decrease over time.
Overall, Maxim Integrated is a solid semiconductor corporation with promising exposure to such markets as automotive, smartphones, and other. It is clear that such growing technologies as EVs and autonomous driving will continue to boost Maxim's performance, evident by the strong results for the December quarter and encouraging guidance. The corporation also looks attractive as an acquisition target, and existing rumors indicate that this scenario is possible.
The stock seems to be reasonably priced at the moment, albeit the margin of safety is rather low. Hence, DCF analysis reveals the fair price range for the stock is $58.3-61.2, compared to the current price of $61. Cautious investors should wait for a pullback to approximately $58 to invest in the company, as this level represents a major technical support.
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Analyst’s Disclosure: I am/we are long AMD. 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.
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