ADI stock pitch april 22, 2007 Katherine Han Analog Devices, Inc. (ADI)
overview of the semiconductor industry from S&P Industry Report and investopedia.com
The pace of change in the semiconductor industry is fast. The semiconductor industry is split into four main categories:
Memory: serve as temporary storehouses of data and pass information to and from computer devices Microprocessors: central processing units that contain the basic logic to perform tasks Commodity integrated circuit: produced in huge batches for routine processing purposes Complex SOC: creation of an integrated circuit chip with an entire system's capability on it
Chipmakers have decreased the cost of production by advancements in technology such as shrinking transistor sizes, increasing wafer sizes, and improving throughput. The industry is so fast paced because it follows Moore’s Law, which says that is the empirical observation made in 1965 that the number of transistors on an integrated circuit for minimum component cost doubles every 24 months. Despite enduring price deflation, the semiconductor industry historically has enjoyed strong unit volume growth to maintain a strong revenue growth and high profitability levels. Key characteristics of successful companies are those that have been able to quickly adapt their corporate strategies in response to shifting trends in end-market demands, competitors’ maneuvers, and legal pressures.
Until recently the semiconductor industry was considered too cyclical and volatile for private investors. However, with the maturing of end markets (e.g., computers and mobile phones), semiconductor sales have stabilized, allowing more reliable revenue and cash flow results. In addition, semiconductor companies have improved management of inventory, capital expenditures, and outsourcing.
business overview from Google Finance and analog.com
Co-founded in Cambridge, MA in 1965, by current Chairman of the Board Ray Stata, Analog Devices makes high-performance analog, mixed-signal, and digital signal processing (DSP) integrated circuits. Mr. Stata served as Chief Executive Officer from 1973 to November 1996 and as President from 1971 to November 1991. Mr. Stata also serves as a trustee of the Massachusetts Institute of Technology. The firm derives more than two thirds of its revenue from converters and amplifiers and about 20% from DSP products.
porter’s five forces analysis
I. Threat of New Entrants: There is fierce competition in the semiconductor industry. American semiconductor industry accounts for half of the global market share. Companies with a new chip that is smaller, cheaper, and faster will compete with existing firms. II. Power of Suppliers: Although the companies currently with the most efficient equipment may have power, their power is temporary, until the next firm discovers something even better. Analog continues to invest in research to remain competitive. III. Power of Buyers: Buyers have power in that they continue to demand chips that are faster and cheaper, which drives the fierce competition of the semiconductor industry. IV. Availability of Subsitututes: Analog Devices continues to evolve with consumer demands. For example, it collaborated with IBM to customize a suite of advanced supply chain planning tools and software that enable ADI to accurately model its supply chain and to dynamically re-optimize production plans at all levels to match customer demand. In addition since the Blackfin Processor’s introduction in 2006, the LabVIEW Embedded Module for Blackfin Processors has been adopted by engineers for the rapid development of sophisticated embedded systems ranging from cutting-edge medical devices to sub-sea monitoring systems. V. Competitive Rivalry – Competition is fierce, but Analog Devices has managed to maintain its competitive edge with its collaborations and products.
Competition
ADI’s current EPS ratio is 1.603 and the P/E ratio is 23.60.
competitor company description EPS P/E implications for ADI ratio STM: STMicroelectronics NV is an 0.83 24.77 Both companies produce STMicroelectronics independent semiconductor company integrated circuits and NV that designs, develops, manufactures products for analog, difital and markets a range of semiconductor and mixed-signal products, including discrete, memories applications and standard commodity components, application-specific integrated circuits, full-custom devices and semi-custom devices, and application-specific standard products for analog, digital and mixed-signal applications. TXN: Texas Texas Instruments has two sectors of 2.783 11.48 This huge company Instruments, Inc. business. One is education produces integrated circuits technology, such as making graphing and is thus directly calculators. The other is competing with ADI. Semiconductor, which designs, manufactures and sells integrated circuits, financials income statement
ADI has experienced increasing gross profit in the past quarters. In general, the company has demonstrated a stable distribution of expenses on research, operations, and administration to main a steady, and now increasing profit. The company’s gross margin (gross profit) has increased, meaning the company will be able to retain each dollar that it earns in its revenue. Although operating expenses have increased, it is investment expenses such as research and development and better marketing.
Feb. 3, Oct 28, Jan 28, 2007 2006 2006 ------Product Revenue $656,614 $644,342 $621,302 Year-to-year Growth 6% 4% 7% Quarter-to-quarter Growth 2% (3)% 0% Revenue from one-time licensing of IP 35,000 ------Total Revenue $691,614 $644,342 $621,302 Cost of Sales (1) 274,594 269,770 260,515 ------Gross Margin 417,020 374,572 360,787 ------Operating Expenses: R&D (1) 143,894 137,550 131,288 Selling, Marketing and G&A (1) 104,681 100,710 96,281 Purchased In-Process Research and Development - 16,211 - Special Charges 5,196 777 1,013 ------Operating Income 163,249 119,324 132,205 Other Income (32,302) (24,495) (20,592) ------Income Before Tax 195,551 143,819 152,797 Provision for Taxes 42,543 6,148 32,240 Minority Interest 219 748 ------Net Income $153,227 $138,419 $120,557 ------
Shares used for EPS - Basic 338,698 346,803 366,135 Shares used for EPS - Diluted 349,208 357,164 380,337
Earnings per Share - Basic $0.45 $0.40 $0.33 Earnings per Share - Diluted $0.44 $0.39 $0.32
Dividends paid per share $0.16 $0.16 $0.12 ------
(1) Includes stock-based compensation expense as follows: Cost of sales $2,936 $2,821 $954 R&D $8,906 $7,415 $10,263 Selling, Marketing and G&A $8,215 $7,363 $10,090 balance sheet
Though these good results are partially due to the semiconductor industry’s general increase of returns, it is important to note that ADI on the five year net margin has seen a 16.3% return on assets compared to the industry’s 16.22%. In addition, for its trailing twelve months ROA (return on assets), ADI is at 15.2% while the industry is at 10.23%.
Feb. 3, Oct. 28, Jan. 28, 2007 2006 2006 ------Cash & Short-term Investments $1,953,821 $2,128,334 $2,735,114 Accounts Receivable, Net 344,783 329,393 317,730 Inventories (1) 385,766 378,651 337,835 Other Current Assets 152,821 174,924 151,302 ------Total Current Assets 2,837,191 3,011,302 3,541,981 PP&E, Net 564,971 562,625 576,798 Investments 32,569 31,429 29,249 Intangible Assets 302,860 299,017 167,186 Other 86,226 82,478 58,964 ------Total Assets $3,823,817 $3,986,851 $4,374,178 ------
Deferred Income-Shipments to Distributors $160,422 $149,543 $132,332 Other Current Liabilities 328,083 341,400 471,851 Non-Current Liabilities 74,105 60,115 60,366 Stockholders' Equity 3,261,207 3,435,793 3,709,629 ------Total Liabilities & Equity $3,823,817 $3,986,851 $4,374,178 cash flows
The cash flows generally look healthy. For cash flows from financing activity, the values of cash flow are increasing after cash is paid as dividends and for re-acquisition of debt/stock. Most importantly, cash flows from operating activities has increased to 30.1% of the total revenue, demonstrating perhaps better management in the company as the net cash is increasing after the company pays its debt.
Feb. 3, Oct. 28, Jan. 28, 2007 2006 2006 ------Cash flows from operating activities: Net Income $153,227 $138,419 $120,557 Adjustments to reconcile net income to net cash provided by operations: Depreciation 35,613 38,904 43,079 Amortization of intangibles 3,610 3,359 404 Stock-based compensation 20,057 17,599 21,307 Excess tax benefit - stock options (6,467) (25,222) - Non-cash portion of special charge - - 459 Other non-cash expense 134 120 557 Gain on sale of investment (7,919) - - Purchased in-process research and development - 16,211 - Minority interest (219) (748) - Deferred income taxes 2,433 3,932 (15,625) Changes in operating assets and liabilities 7,684 (25,839) 4,517 ------Total adjustments 54,926 28,316 54,698 ------Net cash provided by operating activities 208,153 166,735 175,255 ------Percent of Total Revenue 30.1% 25.9% 28.2% ------
Cash flows from investing activities: Additions to property, plant and equipment, net (37,726) (41,755) (20,360) Purchases of short-term available- for-sale investments (646,407) (418,019) (954,871) Maturities of short-term available- for-sale investments 878,619 630,642 726,807 Proceeds from sale of investment 8,003 - - Proceeds from sale of fixed assets - 1,735 - Payments for acquisitions, net of cash acquired - (142,104) - Increase (decrease) in other assets 153 (3,402) 3,526 ------Net cash provided (used) by investing activities 202,642 27,097 (244,898) ------
Cash flows from financing activities: Dividend payments to shareholders (54,737) (55,642) (44,094) Repurchase of common stock (333,223) (357,012) (125,098) Net proceeds from employee stock plans 24,497 14,540 38,685 Excess tax benefit - stock options 6,467 25,222 ------Net cash used for financing activities (356,996) (372,892) (130,507) ------Effect of exchange rate changes on cash 803 (118) 414 ------
Net increase (decrease) in cash and cash equivalents 54,602 (179,178) (199,736) Cash and cash equivalents at beginning of period 343,947 523,125 627,591 ------Cash and cash equivalents at end of period $398,549 $343,947 $427,855 ------
Valuation The semiconductor industry is extremely cyclical and thus susceptible to many ups and downs in the market.
The semiconductor industry is susceptible to cyclical movements. The past six months however, have proved to be an impressive increase in share prices, rising from $29.76 to the current $38.45, rising by 29.2%. Meanwhile, Texas Instruments has moved from $31.37 to $32.49, increasing 3.57%. STMicroelectronics NV has moved from $13.67 to $14.95, increasing 9.36%.
In comparison to its larger competitors, ADI has successfully continued to increase its revenue at a faster pace. Its low P/E ratio demonstrates that there is still room left for the company to grow. Although TXN has a lower P/E, its PEG ratio is higher than that of ADI. Thus ADI is in fact more undervalued.
DIRECT COMPETITOR COMPARISON
ADI STM TXN
Industry
Market Cap:
12.62B 18.45B 46.12B 2.81B
Qtrly Rev Growth (yoy): 11.30% 3.90% 4.20% 15.40%
Revenue (ttm): 2.64B 9.85B 14.26B 1.09B
Gross Margin (ttm): 60.16% 35.81% 51.37% 46.75%
Oper Margins (ttm): 23.79% 7.89% 23.62% 9.48%
EPS (ttm): 1.603 0.83 2.783 0.25
P/E (ttm): 23.60 24.77 11.48 25.75
PEG (5 yr expected): 1.15 1.66 1.33
1.53
P/S (ttm): 4.57 1.88 3.17 2.92
STM: STMicroelectronics NV TXN: Texas Instruments Inc. ADI also has an extremely high return on assets, rated at 14.18, beating the industry’s 11.54, the sector’s 10.67, and the S&P 500’s 8.04. investment opportunities
New Products
2007:
The first investment opportunity is ADI’s new imaging chip, the AD9271. Ultrasound examinations are increasingly conducted in non-traditional environments, such as doctor’s offices, ambulatory units, and remote rural or under-developed locations. This new imaging chip will ease the lack of portability, which has required manufacturers to sacrifice image quality, limiting the medical diagnoses that can be made with portable ultrasound equipment. It integrates a complete eight-channel (octal) ultrasound receiver on a single chip, an unprecedented level of integration allowing medical equipment designers to reduce the size of the signal path for mobile ultrasound systems by 50 percent and lower power requirements by 25 percent, all while achieving noise levels and other performance metrics required in critical care settings.
2006:
Analog Devices, Inc. announced that it has introduced the dual 14-bit analog-to-digital converter (ADC) to achieve sampling rates of 150 mega samples per second (MSPS). This technology supports all third- generation (3G) base station wireless standards, including W-CDMA, CDMA2000 and TD-SCDMA. Two- thirds of the world's 3G cell phones, most of them in Asia, use Analog's semiconductors. Chip sales in China alone exploded 73 percent last year.
Blackfin Processor
Since its introduction in 2006, the LabVIEW Embedded Module for Blackfin Processors has been adopted by engineers for the rapid development of sophisticated embedded systems ranging from cutting-edge medical devices to sub-sea monitoring systems.
Expansion into Asia 2007
Analog Devices, Inc. announced the opening of a joint design laboratory to develop reference designs for China's mobile TV market. The design lab, which is located in Shanghai, will provide complete front-end solutions, from the antenna through the tuner to the demodulator to the MPEG2 TS interface, to allow Original Equipment Manufacturers (OEMs) and Original Design Manufacturers (ODMs) to quickly equip their mobile terminal products--including portable media players, PDAs investment risks slowing industry
The Semiconductor International Association (SIA) provides information on worldwide chip sales from 1982 through 2005. Data shows that there has definitely been a slowdown in the semiconductor industry’s growth rate. During the years 1982 through 1994, chip revenues grew at a compounded rate of 17.9% per year. Since 1994, however, the growth rate has been much slower -- only 7.6% per year. There are also risks in investments in China investment recommendation
Given its strong financials, effective management, and investment expansions, we believe that Analog Devices, Inc. will continue to grow in the next year. We rate ADI a buy at $38.60 and set its target price for $41-43.