2 Stocks to Buy on Bottom-Line Expansion

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The semiconductor industry has recently been receiving favorable commentary given the improving macro environment. In one of my earlier posts, I discussed briefly how an investor can make money by playing one of the themes on this industry. This time around, I have picked up two such stocks that are expected to witness bottom-line expansion in the near future.

NXP Semiconductors N.V. (NASDAQ: NXPI)

The Street maintains a positive outlook on NXP as it expects the company to exhibit levered earnings growth and sees the potential for long-term EPS power of $4.50+. The earnings growth is expected to be driven by accelerating revenue growth, structural gross/operating margin expansion and balance sheet deleveraging. With respect to revenue, a strong product pipeline – Auto, Identification (Authentication, NFC, etc.), Infrastructure & Industrial (High-performance RF) and Portable & Computing (High-speed Interface) – will support long-term revenue growth that is 400-500bps above the industry growth rate.

On margins, the Street sees the potential for NXP to structurally expand its gross margin to ~50% (from current ~46%) and drive the operating margin to ~25% (from current ~20%) over the next 6-12 months. In the long run, the Street sees the potential for NXP to improve gross margin to the target of 52-56% and operating margins to the high-end of the target range of 23-28%. Finally, with respect to NXP’s balance sheet, NXP has net debt of $2.88 billion, resulting in net leverage of 2.9x. NXP is expected to continue to pay down debt with its free cash flow generation and drive the company’s net leverage to at least 2.0x – it is interesting to note that NXP currently has ~$0.85 of EPS tied up in interest expense.

SanDisk Corp (NASDAQ: SNDK)

The Street seems to be bullish on this stock. While C4Q (fourth quarter in the calendar year) has usually been a time to lower exposure to SanDisk ahead of seasonally poor NAND (a storage technology that doesn’t require power to retain data) pricing in C1Q, the analysis suggests that “normal” seasonal is likely to be more than offset by structural, cyclical and company-specific product drivers. For C1Q13, the Street sees sequential NAND supply growth of +6% versus demand growth of -1%.

More importantly some analysis suggests undersupply throughout 2013, as cyclically depressed CapEx and structurally increasing capital intensity will support supply growth of only 35%, versus smartphone, tablet and SSD (Solid State Drive that offers remarkable data speeds and low power consumption) demand, which is likely to underpin overall demand growth of 45%. In addition to positive industry fundamentals, a positive mix shift is expected at SanDisk (from Consumer, USB and Cards to Embedded and SSD), which should drive incremental leverage. While the consensus CY13 EPS estimate is of $3.45, a potential upside to $4.50 is expected over the next 12-18 months, as the estimates do not fully reflect the expectations for continued cyclical strength or the structural mix shift to higher margin products.

Data storage solution providers have been hot with the hedge funds lately. Only recently, David Tepper’s Appaloosa Management increased its stake in two such stocks, namely SanDisk and EMC Corp (NYSE: EMC). Many people believe EMC to be as attractive an investment as SanDisk. However, what people need to consider is that where SanDisk is expected to witness 20-25% EPS expansion in the next five years or so, EMC might only see 12-13% growth. The only thing in common is that both have a solid exposure to the macroeconomic environment, which is currently considered to be bullish.

Foolish Bottom Line

Both SanDisk and NXP seem to be attractive investments given that they are not only set to benefit from the changing macro environment but also have internal bottom-line growth factors at play.

AnalystX has no position in any stocks mentioned. The Motley Fool recommends NXP Semiconductors . The Motley Fool owns shares of EMC. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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