Xilinx, Altera More Undervalued Than TI
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Despite an uncertain economy, a few semiconductors are still closer to their 52-week highs than 52-week lows. Altera (NASDAQ: ALTR), Xilinx (NASDAQ: XLNX), and Texas Instruments (NASDAQ: TXN) all offer different risk/reward profiles at this point based on their fundamentals. While TI retains its position as an industry leader, the other two producers have dominant market shares in a few niches. It is therefore important to understand the subtle nuances between each firm.
Altera designs programmable logic devices that are manufactured as standard chips and add functionality to electronics. They also manufacture HardCopy ASIC devices that enable migration from PLD to a non-programmable implementation of their own designs. By contrast, peer Xilinx works more purely in the programmable platform market that includes PLDs and software design tools, printed circuits, and customer training. Altera is the slightly bigger company, and its slightly larger economic moat enables the firm to trade at a premium. Over the last twelve months, this premium has declined, as Altera lost 3% in value while Xilinx gained 10.5%.
That gap may close now that Xilinx has boosted Q3 guidance, albeit slowly, and Altera has not. Performance has also been much more solid for Xilinx over Altera, with the former beating expectations consistently by an average of 10% over the last five quarters while the latter missed expectations for two of those quarters. Even still, Altera's overall performance has been good with EPS of $0.50 in 2Q12 being 28.2% better than originally forecast by analysts. This quarter was particularly strong given that Altera returned to sequential quarterly growth after three quarters of sector-wide inventory reductions. 28-nanometer performance did so well (as evidenced by the 166% growth) that Altera is now the market share leader. Not to go un-noted, 40-nanometer increased 42% sequentially and represented the biggest category in terms of sales.
All in all, the consistent operating performance and growing reach of Xilinx makes me optimistic about it continuing to close its value gap with Altera. The former trades at a respective 18.9x and 16.2x past and forward earnings while Altera trades at a respective 19.8x and 17.8x pasta and forward earnings. Over the next five years, analysts expect Xilinx to grow EPS annually by 13.7%--more than 100 bps lower than what is forecast for Altera. And for good reason. Over the last five years, Altera has grown at a significantly faster rate than Xilinx. In terms of their balance sheets, both have excellent liquidity (quick ratios and current ratios around 6 and up) to finance this growth, but Xilinx is slightly better. While both firms have solid fundamentals, I recommend preferentially purchasing shares in Xilinx in the shorter-term to benefit from multiples correcting.
TI is several folds larger than Xilinx and well known by the market for its supposed stability. But over the last few years, EPS has been (understandably) shaky - going from $1.83 in 2007 up and down to eventually $1.88 in 2012. EPS may have beaten expectations in five of the last quarters by an average of 7.8%, but the future growth curve is simply not ideal for investors looking to get in now, as evidenced by the 2.3x PEG ratio.
This leading semiconductor now trades at a respective 20.9x and 13.7x past and forward earnings with a dividend yield of 2.4%. As far as volatility goes, TI is very stable for semiconductors with a beta of 1.1. ROE and ROI may both be in the double-digits, but annual EPS growth forecasts are lower in the high single-digits over the next five years. That may seem like a lot, but, again, you are expected to get around at least 400 bps greater growth each year over the next five with Xilinx and Altera at lower multiples. You can think of this as the price you have to pay for stability.
Of course, there is little reason to accept the price if the stock goes down in value. There is no way for TI to be undervalued at a 10% discount unless its multiples increase. At 20.9x past earnings, the company is already at a sizable premium to its historical 5-year average PE multiple of 17.1x. Accordingly, I recommend investors hold out and back riskier stocks like Altera and Xilinx.
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