High Performance Analog: Interesting Growth Idea

I recently closed out a position in Linear Technology (LLTC), on valuation, pocketing a small but quick profit. I started to work on an article about the company and the decision, but when I started digging into it, there's more to it than just valuation.

Briefly, HPA (high performance analog) semiconductor chips play an important role in moving analog information over into the digital world where it can be worked on for process control in industrial or automotive applications, and elsewhere. According to CFO Paul Coghlan, on the most recent conference call:

Our bookings were particularly strong in end markets of concentration for us: industrial and automotive. Both of these end markets are in innovation cycles, energy efficiency in industrial and higher electronic content in automotive. Both of these end markets are also the fastest growing within the analog industry. In the last 3 calendar years, the overall analog market grew at a 7% compounded annual growth rate. Whereas within analog, industrial grew at a 12.8% compounded annual growth rate and automotive at a 22.6% rate. Linear itself overall grew 12.5% compounded for the 3-year period.

Reading through the call, it appears that LLTC, already a pure HPA play, is focusing on the high margin, high growth automotive and industrial end-user area. The company has excess capacity, so growth should make it straight down to the bottom line.

Industry players have been rising rapidly, and trade at premium multiples:

So, here we have LLTC, plus competitors Analog Devices (ADI), Maxim (MXIM) and Texas Instruments (TXN) trading at an average P/E of 22.2. These names were taken from LLTC's 10-K, where they are listed as important competitors. Microchip (MHCP), which I hold in the Synthetic Dividend Growth Portfolio, is also a competitor. Here's an excerpt from a recent conference call:

Moving to our analog products. Our analog business grew 4.1% sequentially in the March quarter to also achieve a new record and continues to perform exceptionally well. Analog revenue was up 12 -- 124.4% versus the year ago quarter. While for fiscal year '13, our analog business was up 89.4% as compared to fiscal year '12, easily one of the best-performing analog businesses among our peer group. Analog revenue represented 22.6% of Microchip's overall revenue in the March quarter, and that's the highest proportion of our revenue ever.

It appears that new applications in automotive and industrial are creating considerable potential for HPA. Recent price action in players with an exposure in the area indicates market awareness of the potential here. However, it's difficult to quantify and the market as we know blows hot and cold. I already have a position in TXN, which has risen rapidly during the month I've had it in the Syn DGI portfolio.

Anyway, I'm going on a family vacation next week, and won't be posting. When I get back, I plan to do an in depth study of this HPA area, to develop investment ideas and strategy for a situation that could develop favorably over the next several years.

Disclosure: I am long MCHP, TXN.