Ignoring This Stock Isn’t a Good Idea, Even Though it’s Witnessing Short-term Weakness

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When Singapore-based semiconductor company Avago Technologies (NASDAQ: AVGO) released its first-quarter report last week, it didn’t spring much of a surprise. The company met expectations on revenue and beat on earnings, but this is the least it should have done, since estimates were already quite low after Avago had issued a gloomy outlook the quarter before.

However, Avago guided below Street expectations yet again for next quarter. While analysts were expecting a sequential increase in revenue to $583 million, Avago thought otherwise. It expects its top line to shrink 2% to 5% in the second quarter, as a product ramp up at its Korean customer won’t be enough to offset the annual product transition at its North American customer.

A quarter’s pain

As you would have guessed, these customers are Apple (NASDAQ: AAPL) and Samsung, to whom Avago supplies wireless chips that prevent interference between various kinds of radio signals. According to CEO Hock Tan, product transition at Apple has arrived a quarter earlier this time, and this knocked out some wind out of Avago’s sails.

Apple, through Foxconn, accounted for 17% of Avago’s revenue last year. Thus, the weakness of the latest iPhone was bound to have a negative effect of Avago this quarter. According to Jefferies analyst Peter Misek, sales of iPhone 5 have slowed down earlier than expected, leading Apple to issue further order cuts.

However, as Misek pointed out, preparation for the next iPhone is expected to start this month. As the iPhone transition appeared a quarter earlier, one can expect Apple to start preparing its next flagship earlier as well, and this should help Avago in the next quarter when orders start flowing in.

The presence of Samsung as a customer was the saving grace for Avago, as it acted as a hedge against Apple's weakness. Avago had supplied chips to Samsung for the Galaxy S III. With the next iteration of the Korean giant’s flagship on the horizon, Avago saw better orders from Samsung, and this salvaged its outlook to some extent.

A bite of the berry

Another shot in the arm for Avago could be its presence inside BlackBerry’s (NASDAQ: BBRY) messiah, the Z10. Even though the flagship has yet to be launched in the U.S., it is off to a good start in other countries. For instance, reports suggest that the Z10 appears to be doing well on its home turf in Canada, as well as in the U.K., by taking away share from other platforms.

Moreover, the smartphone has started off well in an important market such as India despite steep pricing, which establishes the fact that consumer loyalty could help BlackBerry regain some of its lost market share. This, in turn, should prove beneficial for Avago.

Apart from these bigwigs, Avago is also finding traction at other phone makers in regions such as Taiwan, Korea, and China. Growth of 4G LTE devices and increasing FBAR content are expected to help Avago going forward. The company invested $300 million for quadrupling its FBAR capacity, as it expects increasing sales of LTE devices to result in higher demand for its chips.

The other businesses

The story in Avago’s wired infrastructure business was somewhat similar to that of the wireless business as transition at a major customer weighed on growth. However, the company believes that its enterprise network has hit bottom and a ramp up of 40G data center switching will lead to a sequential improvement in this business.

However, Avago’s industrial business is still seeing weakness, and is not expected to return to growth in the near future. Slow industrial growth in China was offset by declines in Europe and Japan. Upticks in the industrial business will depend on economic recovery, and until and unless this recovery becomes sustainable Avago doesn’t expect this business to run on full power.

Final words

Avago has gained close to 6.5% so far this year, but there seems to be a question mark about whether or not it will be able to keep up its momentum. Its wireless business will have a tepid quarter, while the industrial market is not in the best of health. A recovery in the wired infrastructure business is in the cards, but it won’t be enough to offset the declines in the other two.

Speaking of the long-term, Avago looks like a solid company. It has a diversified business, pays a dividend, has almost no debt, and boasts of bellwether clients such as Apple, Samsung and Cisco. However, investors might consider waiting for the shares to get cheaper from the 15 times earnings they currently trade at, and should keepin an eye on the recovery of its end markets.  

TechJunk13 has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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