The day on which semiconductor player Analog Devices, Inc. (NASDAQ:ADI) closed in on its 52-week high turned out to be the day when it posted disappointing earnings. The company missed estimates on both top and bottom lines and issued a cloudy forecast for the ongoing quarter. Analog’s revenue estimate of $647 million to $672 million for the current quarter is behind the consensus of $666 million at the mid-point, as it wades through macroeconomic weakness.
However, Analog managed to appease investors to some extent as it bumped up its quarterly dividend by 13% to $0.34 per share, which translates into a forward dividend yield of 3%. This probably saved the stock from a huge sell-off, but it’s still down 4% since reporting earnings last Tuesday.
The stock has appreciated around just over 13% in the last one year, but might see some tough times ahead after a weak earnings report and outlook. Thus, investors could probably think of adding to their Analog position when the stock is down since it expects a recovery is on the way. But will it be the right thing to do? Let’s check.
Hitting bottom
Analog witnessed tepid sales in the early part of the previous quarter, but saw an improvement towards the end. According to management, order rates are now better than before and continue to be strong. Analog’s confidence stems from the fact that its industrial customers are expected to perform better in 2013. Industrial customers have kept their orders below consumption and they are probably through with inventory de-stocking, which could be one of the reasons behind improved order rates.
In addition, Analog expects the industrial market to provide it with opportunities for its analog signal processing business. It expects machine automation, power grid management and precision instrumentation to increase its addressable market in the future. Also, an increase in auto sales over the past year and expectation of further growth in the future are catalysts which Analog Devices expects to ride.
The industrial and automotive business contributed 62% to the company’s total revenue in the previous quarter. But both were down on a year-over-year basis, with industrial declining 3% and automotive falling 11%. However, if the recovery about which management speaks is indeed true, and the previous quarter was indeed a “trough,” then Analog can surely expect better returns from these businesses in the future.
Down, but not out
However, the most concerning part about Analog Devices is the sudden halt of its communications infrastructure business, which constitutes 20% of its overall revenue. After being on a roll for most of last year, the segment declined 12% sequentially due to weakness in wireless infrastructure. But, the company would probably see an improvement in this business as well, since telecom carriers such as AT&T Inc. (NYSE:T) are expected to increase their spending on next generation networks.
AT&T would be spending $14 billion over the next three years for enhancing its wireless and wireline networks and expand its 4G reach to 300 million customers by the end of next year. Ma Bell is aggressively penetrating the 4G LTE market, and through these investments it expects to extent LTE services to 99% of its customers in 22 states.
AT&T’s move might result in investments by peers to upgrade their networks. Hence, it’s not surprising that research firm Gartner projects that spending on telecom infrastructure would increase this year. Moreover, the solid performance and outlook of a component supplier such as JDS Uniphase Corp (NASDAQ:JDSU) last month suggests that the recovery is for real.
Uniphase called for revenue of $405 million to $425 million for the ongoing quarter, in line with analyst estimates, as management was buoyed by expectation of higher investment in network infrastructure. Like Analog Devices, even Uniphase is counting on data centers and rollout of LTE services to drive growth and is on the cusp of landing some more design wins for its new products.
Although Analog didn’t provide a separate outlook for this segment, it remains upbeat about the prospects of its communications infrastructure business in pretty much the same way like Uniphase. It has invested in wireless and wireline technologies apart from expanding its reach in the Asian market. These moves should help Analog in the future as spending resumes.
The takeaway
Analog’s current valuation might be another put-off for investors. Paying 21 times trailing earnings for a stock which is presently on sticky ground might not be an attractive proposition for most, but Analog is a diversified semiconductor play and should do well across economic cycles. Moreover, the company has a strong balance sheet with almost $4 billion in cash and short-term investments and generates solid cash from operations.
Also, analysts expect growth in earnings going forward, as evidenced by a forward P/E ratio of 17 times. Keeping all these factors in mind, it would be advisable to add the stock to your portfolio on weakness since it’s probably on the verge of a recovery and is well-positioned for the long run.
The article This Company’s Recovering Business Makes it Worth a Look originally appeared on Fool.com and is written by Harsh Chauhan.
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