A Promising Semiconductor Stock for your Portfolio
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Patience is a virtue. And in fundamental investing, patience is a tenet that is worth its weight in gold. Toward the beginning of my blogging career at The Motley Fool, I had written a post on Avago Technologies (NASDAQ: AVGO), telling you why the semiconductor company would make for a good long-term investment.
Five months and numerous posts later, I see that the stock has returned a shabby 3% since I covered it first. But the journey hasn’t been an easy one. The company has been on an upswing since it posted its second quarter results three months back, contributing 22% to investors’ coffers in that period. Patience is indeed a virtue.
In the third quarter as well, the company trumped consensus estimates. But Avago isn’t done yet. The Singapore-based maker of communication chips has got more fuel in the tank, even though a light outlook for the ongoing quarter might prove to be a slight hiccup. So, before I tell you good things about Avago, let’s get the bad part out of the way and see what led it to issue a sordid outlook.
The problem
One small portion of Avago’s business (7% to be precise) is made up of consumer and computing peripherals. But this business has fallen prey to weakness in PC and printer demand, according to the company’s 10-Q filed last quarter. In addition, Avago states that this segment is “a mature and non-strategic market” and it is shifting the way it’s conducting this business.
The company is now licensing or selling its intellectual property in this market to earn royalty, instead of actually making products. And for the current quarter, Avago projects a sluggish performance by its consumer navigation business, significantly down from the 33% year-over-year growth it recorded in the just-concluded quarter. Hence, while the ongoing quarter might be a dampener for this business, I think Avago is following an intelligent path over here by changing its model as it will enable it to focus more upon the core areas.
The weapon
Let’s now get to the main driver. Avago’s wireless business is the one that is supposed to drive its top line higher going forward. However, the segment was handicapped in the previous quarter, but the reasons were not unexpected. Firstly, supply issues for Qualcomm's (NASDAQ: QCOM) 28nm LTE baseband chipset played its part.
Even though the Qualcomm says that supply will continue to be on sticky ground till the end of the year, Avago is of the opinion that it has witnessed improvement in supply. As a result, the company is witnessing an upswing in demand for its radiofrequency (RF) solutions.
The second problem that Avago faced was that of “product transition cycle at one of our large OEM customers.” The words in quotes are quite significant, and warrant a detailed discussion.
The trump card
Last quarter, a few companies, such as Skyworks Solutions (NASDAQ: SWKS), had the same problem. As its key customer was waiting to bring a new product to the market, Skyworks expected a soft quarter. But now, that key customer is ready to launch its next product pretty soon.
I’m talking about Apple (NASDAQ: AAPL) here. Skyworks is now well on track and expects a terrific second half of the year as it expects to sell more components to Apple. And as far as Avago is concerned, it has done very, very well to be counted as an Apple supplier. The company’s innovation enabled it to replace three components in the iPhone 4S last year, and Skyworks was amongst the losers then.
With the next iPhone on the way soon, Avago is ready to make merry and expects its wireless business to gain 20%-30% sequentially. Also, Avago also supplied to the 4G version of the iPad launched earlier this year. Thus, it seems that Avago’s chips are finding some good traction at Cupertino, and this is another reason why I’m counting on it to do better going forward.
Bad, but not so bad
Also, the company’s other businesses, namely wired infrastructure and industrial and automotive, are getting better. Both these businesses improved sequentially in the previous quarter as strong demand for 2.5G and 5G products from service providers grew. However, the wired business might again be in for a difficult time in the current quarter as growth from data center switching would be mitigated by sluggishness in core routing programs.
However, it should be kept in mind that Avago’s wired infrastructure business is well-positioned to gain from more data center build outs in the future. In addition, recovery in the industrial and automotive business is expected to continue as we move forward, but the European market is playing spoilsport here. The business is finding good traction in other regions but not in Europe. This might lead to sluggish growth of the segment in the current quarter.
The final summary
CEO Hock Tan said that only one business will be running at full charge for Avago, and that’s the wireless business. The wireless business has been growing very well for some time now and I won’t be surprised if it makes half of the company’s revenue very soon from the current 40%. As far as the other two are concerned, they have been slowing down due to low spending by original equipment manufacturers as infrastructure spending is a bit low.
But even in those two businesses, Avago has provided us with good positives. Thus, if we look at all three businesses in isolation, the wireless one is doing nicely, while the other two have potential. Avago supplies chips for consumer appliances, data networking, telecommunications equipment, and enterprise storage and servers, among many others. While these businesses may be a bit off color now, they would most probably get better in the long-term. Also, a dividend yield of 1.60% is another positive which might entice you into buying Avago.
TechJunk13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Qualcomm. Motley Fool newsletter services recommend Apple. 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. If you have questions about this post or the Fool’s blog network, click here for information.
