This Fast-Growing Semiconductor Company Looks Undervalued

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

With all the turmoil going on in the world of semiconductors since the advent of mobile computing technology, it’s easy to overlook some of the smaller names in the sector. As such, most discussions focus on the bigger players that dominate their respective industries. However, the opportunities for growth may be much more enticing in some of the small-cap companies that make chips for mobile handsets. One of these promising companies is RDA Microelectronics (NASDAQ: RDA).

Introducing RDA

RDA is a Chinese fabless semiconductor company, meaning that they rely on other companies for the actual manufacture of their chips. The company designs a range of products primarily for incorporation in mobile handsets and set-top boxes, including baseband chips, power amplifiers and Bluetooth systems, and  it is mainly active in the Chinese market. The stock has a fairly small market cap of around $490 million and only 362 employees. With a beta of only 0.28, the stock isn’t very volatile at all and is up around 5% in the last year.

Earnings Growth

Since becoming a publicly traded company in 2010, RDA has been doing a great job of growing earnings. For its first quarterly report, that of Q4 2010, the company delivered EPS of $0.24 versus a consensus of $0.05. Since then, annual EPS has increased steadily, going from $1.11 in 2011 to $1.34 in 2012. Analysts are expecting annual EPS of $1.49 for fiscal 2013. Looking at quarterly reports, the company hasn’t missed a single quarter so far.

The last quarterly report for Q1 2013 was fairly upbeat. Revenue increased nearly 35% to $97.1 million, and gross margin increased from 31.7% to 32.1%, while EPS of $0.28 met the analyst consensus. The company is betting heavily on the Chinese low-cost cellphone market and is seeing strong demand for its Wi-Fi combo chips. Looking ahead, the company expects revenue around the midpoint of guidance for Q2 2013, with gross margin improving to around 32.3%.

Competitors

Broadcom (NASDAQ: BRCM) is one of the companies competing with RDA in the lower end of the smartphone spectrum, having recently introduced a chip for entry-level Android devices. After growing annual earnings quickly up until 2010 or so, growth seems to have stagnated a bit, with annual EPS growing by only $0.03 from 2011 to 2012. Looking forward, Broadcom has a 3-5 year expected growth rate of around 24.5%, while RDA is expected to grow earnings by 37.4% in the same period.

Qualcomm (NASDAQ: QCOM), the dominant force in mobile processing, has also entered the market for lower-end mobile processors, especially in emerging markets. Several new Snapdragon chips are now specifically aimed at the exploding Chinese smartphone market. Presumably, this is a response to cheaper Asian manufacturers gaining some market share in this segment. While Qualcomm has been delivering good growth over the last years, the 3-5 year estimated growth rate of 20.5% suggests that investors may be better off with the smaller names in the search for more aggressive growth.

Valuations and Metrics

RDA Microelectronics is simply cheap at the moment, with the P/E at 9.74 times trailing earnings and the forward P/E at only 5.95. For comparison, Qualcomm trades at 17.38 times trailing earnings, and Broadcom at 23.5. Similarly, RDA’s PEG ratio is very low at 0.59, and the price-to-sales stands at 1.17. The gross margin of 32% is quite a bit ahead of the 17% industry average, and the return on equity is quite good at 23.81%. The company moreover has no debt on the books and around $114 million in cash.

The Bottom Line

While the more established chip makers arguably offer increased stability in a tumultuous market, the smaller names are perhaps better choices in terms of growth. RDA Microelectronics, while not a particularly well-known name in the industry, has been doing a good job of acquiring market share in the lower end smartphone segment, especially in China. With strong earnings growth, and a low valuation, the stock looks enticing.

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Daniel James has no position in any stocks mentioned. The Motley Fool owns shares of Qualcomm. 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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