After Proving Its Mettle, This Company Is in for Better Times Ahead

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It doesn’t take long for fortunes to change on the Street. Avago Technologies (NASDAQ: AVGO), which was mired in short-term weakness just a quarter ago, bounced back with a vengeance after beating consensus estimates in the second quarter and issuing a sunny guidance for the ongoing one.

Unsurprisingly, analysts started their customary price upgrades and investors were raving about the prospects of the company. However, Avago’s long-term growth story was never in doubt and the weakness in the previous quarter was just a temporary incident driven by seasonality.

Avago’s diversified business; its compelling valuation, an almost pristine balance sheet, and a solid dividend yield are some good reasons why this stock can still find a way into your portfolio. More importantly, the company’s end-markets should only get better from here and it won’t be surprising if Avago goes on a market-beating run from here.

Apple’s back and Samsung rocks

The major reason behind Avago’s tepid outlook three months back was the product transition at Apple (NASDAQ: AAPL), which had happened a quarter earlier than usual. However, Avago also supplied content for the Samsung (NASDAQOTH: SSNLF) Galaxy S4, and this acted as a hedge against lower orders from Foxconn (aka Apple).

Avago has got multiple catalysts to drive its wireless business, which accounts for half of its overall revenue. Firstly, management stated that they are at the beginning of “a very strong ramp from our North American smartphone OEM customer as they transition to the next-generation platform.”

Now, Avago had supplied wireless chips for the iPhone 5 that prevent interference among radio signals, and with Apple reportedly targeting a September launch, component suppliers such as Avago should see a couple of strong quarters going forward. Apple had faced supply constraints last time due to overwhelming demand for the iPhone 5, and the smartphone behemoth wouldn’t probably take such chances this time.

Also, with the rumors of a cheaper iPhone getting stronger by the day, with some suggesting that Apple might even start production next month, Avago might see its addressable market increase if a budget iPhone is indeed launched.

In addition, we shouldn’t discount the prospects from the company’s Samsung account, and sales of the Galaxy S4 to be precise. Samsung’s latest flagship is the fastest selling Android phone ever and, if analysts are to be believed, might hit 80 million in sales this year. Thus, the production ramp up at Apple and the strength of the Galaxy S4 should continue to be tailwinds for Avago going forward.

Moreover, Avago’s mobile business should benefit from the proliferation of 4G devices and its presence in budget smartphones in regions such as Taiwan, Korea, and China.

Wired infrastructure and industrial getting better

Avago saw revenue from its wired infrastructure business, which accounted for 27% of total revenue, grow 7% on a sequential basis. The jump was driven by recovery in enterprise spending on the back of data center build outs. Going forward, Avago is expecting the growth of data centers to drive its infrastructure business as the company has landed a few design wins.

In addition, the industrial end market also turned in a revenue improvement of 4% on a sequential basis, which was surprising as Avago had expected a decline. This unexpected improvement helped the company beat estimates and the trend is expected to continue as Avago is looking at growth in mid-single digits in the industrial business in the ongoing quarter.

However, investors do need to keep a couple of things in mind. Avago isn’t witnessing solid demand from carriers in its wired infrastructure business as telecom spending isn’t picking up as expected. But then, the build out of the TD-LTE network in China may provide it with some more push. Also, while the company is expecting a good performance from its industrial business, a slowdown in the global economy, especially in China, might turn the tables against it.

Why buy

There might be more exciting companies out there to ride the growth of smartphones and tablets, but Avago’s exposure to the industrial and wired infrastructure markets, which are showing signs of recovery, gives it more revenue streams which shouldn’t be ignored.

A trailing P/E of just 17 times, which is well below the industry average, and a forward P/E of around 13 look pretty enticing for a semiconductor stock that’s offering diversification, growth, stability, and a dividend yield of 2%.

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Harsh Chauhan 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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