Here's Why Silicom Ltd. Should Destroy Earnings Expectations Tomorrow

Silicom reports earnings on Thursday and operates in some of the hottest markets in the world. Here's why you should get in before it's too late.

Apr 23, 2014 at 11:30AM

Silicom (NASDAQ:SILC) is due to report earnings on Thursday, April 24 before the market opens. According to Yahoo! Finance, there is only one analyst that has profit expectations, Needham & Company. It expects Silicom to increase earnings by 15.2% to $0.53 per share on $18.79 million in sales. Silicom should crush -- not just beat -- this number.

There are three reasons to be confident about an investment in Silicom. The company is increasing its penetration in hot markets like the cloud, big data, security, and virtualization. It's run by forward-looking management, who has shown the ability to spot trends before they occur. Plus, the economics backing this business are very good.

Images

Source: silicom.com.

Strong relationships in hot markets
Silicom works with original equipment manufacturers, or OEMS, like Cisco and Intel (NASDAQ:INTC). Specifically, Intel is becoming more of a partner. Silicom provides several products including server adapters, time-stamping solutions, and its patented switched SETAC for Intel's software-defined networking solutions, or SDNs. Plus, that relationship is growing; Intel accounted for more than one-third of Silcom's revenue in 2013. 

Here's what Frank Schapfel, Director of Marketing at Intel's communications and server infrastructure division, had to say: 

Higher-performance encryption and compression offloads are two of the significant challenges that high performance servers must overcome to achieve target performance levels, especially in the SDN and Cloud space. Silicom is addressing this pain point with a comprehensive suite of cards that integrate encryption and compression functionality. This is an important offering that we believe will answer the needs of performance-hungry servers in both the SDN and Cloud markets, as well as in the traditional networking appliances markets...

Setac With Text

Source: silicom.com.

While Intel may be Silicom's biggest customer, it's certainly not the only one. Silicom offers network appliances to more than 90 other companies. While it doesn't specifically name these companies as customers, it's a good bet that it has done business with leading players like Cisco, Juniper NetworksCheckpoint Systems, and F5 Networks. Silicom and its customers work together to devise unique solutions that lead to design wins, a wide variety of products, and future cross-selling opportunities. The switching costs are also high, which bodes well for Silicom. 

Trend-spotting stewards
Silicom has great management, and CEO Shaike Orbach has been running the company for more than a decade. Whether it's his patented SETAC, or server to appliance converters, his nano-second time-stampers, or his encryption accelerators, he has consistently shown an ability to get ahead of trends and direct his engineers to offer valuable solutions.

He's also proven to be a good steward of the company -- not many $400 million tech companies pay a dividend. Based on last year's results, Silicom announced a $1.00 per share dividend, which is about 2% of the stock's price. The year before, it paid out a $0.55 dividend based on 2012 results. If the company continues to knock it out of the park, you can expect further lucrative payouts. 

And now the numbers
Last year, Silicom nearly cleared $75 million in sales with a 40% gross margin and almost a 25% net margin. Between 2009-2013, it increased sales by an average of 38% and its bottom line by 59%. Plus, the growth of its top line is accelerating, as last year's sales were up 50%. This is a company that is very early in its growth cycle. 

The Needham expectation of only $0.53 on $18.79 million is a low hurdle to hop. Perhaps it's so low because there is a new manufacturing building set to hit this quarter. Or, maybe it's because of the strengthening Shekel (Silicom is an Israeli-based company). Whatever the case, as long as Silicom continues to leverage its operating expenses (22.4% in 2010 to only 15.4% last year), it should continue its outstanding performance.

Foolish final words
Silicom is a great business, run by great management, that operates in a booming market. It's set to report earnings Thursday morning and should blow expectations away. While we never know what the market will do to a stock, it's tough to argue with the quality of Silicom's business.

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Wade Michels owns shares of Silicom Ltd. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. 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.

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