Monday, August 04, 2014

Investing in Semiconductor Technology Earnings Growth

Avago Technologies (AVGO), a Singapore incorporated company with joint headquarters in San Jose, California, is a leading designer, developer, and supplier of a broad range of analog semiconductor devices and digital, mixed signal, and optoelectronics components and subsystems. These innovations are used in wide range of wireless, wireline, and industrial applications.

Avago started as a Hewlett Packard (HPQ) semiconductor division in the 1960's and was later a part of Agilent that was spun-off from HP with an IPO in 2009. The $18 billion company makes radio frequency chips that are used in smartphones by Apple (AAPL), Samsung and other mobile device manufacturers.

Avago products primarily serve four markets: Enterprise Storage (38% of FY 2013 revenue), Wireless Communications (25%), Wired Infrastructure (23%), and Industrial & Other (14%). It has a diversified revenue model with 37% of its FY 2013 revenue derived from China, 20% from North America, 10% from Europe and 33% from the rest of the world.

Solid Q2 Report

On May 29, Avago reported its financial results for Q2 of its fiscal year 2014, ended May 4. Net income for the quarter was $158 million or $0.61 per share, up from net income of $134 million or $0.53 per share for the prior quarter and net income of $113 million or $0.45 per share in Q2 last year.

According to the management, “our wireless business came in significantly above our expectations due to strong product ramps for our FBAR-related products into multiple Asian Smartphone OEMs. We also saw resurgence in Industrial re-sales through our distributors, especially in Europe and Japan”.

On May 6, Avago closed the acquisition of LSI Corporation. Subsequent to the acquisition Avago joined the S&P 500 index, replacing LSI Logic.

Vertical EPS Revisions

In mid-June, my colleague Neena Mishra wrote on Avago as Bull of the Day and noted "As a result of continued solid performance, the Zacks Consensus Estimates for FY 2014 and 2015 have increased to $3.29 per share and $4.51 per share." The EPS table below shows the most recent consensus estimates and explains whey the stock became a Zacks #1 Rank again this month as analysts kept raising their numbers.

You can also see that these are the kind of implied growth rates that make growth stock portfolio managers salivate. What this table doesn't show you is where those consensus EPS estimates were before the most recent company guidance. 2014 estimates were raised from $3.01 to $3.31 (+10%) and 2015 estimates were hiked a whopping 31% from $3.50 to $4.59. That's a powerful bump in the company's earnings momentum and outlook.

Analysts and Funds Target Higher Prices

After that earnings report and the subsequent estimate bumps, I took a look at this Zacks #1 Rank to see if it had something else that makes it a buy for me: strong institutional interest. I found that the $275 billion Capital Research Investors disclosed a big position of 25.8 million shares (10% of the company) in early May in a 13G filing.

This was likely in reaction to the company being added to the S&P 500 after they closed their acquisition of LSI. But knowing some of the holdings and strategies of Capital Research, a sister fund of the equally large Capital World Investors, this is a growth play for them as well.

In July, Stern Agee analysts reiterated why Avago had been recently added to the firm's Best Ideas list with a $93 price target, noting that "execution discipline and product leadership make it top holding."

The analysts hosted investor meetings with AVGO's CFO and gave these "key takeaways: 1) expect a strong 2H with China builds and marquee phones, no supply chain slowdown, 2) LSI synergies running ahead of time line driving upside GM-OM versus consensus, 3) increasing 2H14-2015 Wireless content as 4G ramp focuses handset OEMs on FBAR as key, and 4) stable HDD, Wired 40G Bi-Di ramps, and hyperscale storage demand, combined with a focus on execution, should make AVGO a top L-T stock. Raising estimates and PT to $93."

And after Apple's earnings, Oppenheimer analysts, who have an Outperform rating on AVGO shares, were even more positive. Here's what they had to say...

"AAPL represents ~15-20% of Avago sales before the acquisition of LSI. The company primarily supplies RF filter and power amplifier components in the iPhone/iPad. Following the LSI acquisition and AAPLs move back to a single SKU for iPhone 6 we believe AVGO could see 30%+ content gains on iPhone 6."

Bottom line: In a strong semiconductor industry, this is one large cap name I want to own for growth with solid business footholds in both enterprise networking and mobile devices. They would seem to benefit from all dimensions of a more connected world.

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