3 Reasons Analog Devices, Inc. Will Go Higher

Strength in automotive, industrial, and communications can take this chipmaker to new highs.

May 19, 2014 at 12:45PM

Chipmaker Analog Devices (NASDAQ:ADI) started the year poorly because of uncertainty in its end markets and an analyst downgrade. The company was seeing weakness in ordering patterns, similar to peer Texas Instruments. But, the problem was short term in nature. The automotive market is picking up and telecom players such as China Mobile (NYSE:CHL) and Verizon (NYSE:VZ) are aggressively moving forward with their LTE initiatives.

Also, Analog's book-to-bill ratio in the first quarter was above one as order rates improved. In addition, the company issued strong guidance, hiked the dividend, and bumped up the share repurchase authorization by $1 billion. Moreover, as Analog's different end markets are expected to get better this year, things are moving in the right direction.

A strong auto market will be a tailwind
Analog derives 20% of its revenue from the automotive segment. Global auto sales hit a record high of 82.8 million vehicles in 2013, according to IHS Automotive. So, it wasn't surprising to see that Analog's revenue from automotive increased 15% year over year. This year, the auto industry is expected to put in yet another year of strong growth, clocking 85 million in sales. In addition, the long-term forecast is also quite rosy, with the 100-million-vehicle mark expected to be breached in 2018. 

Analog supplies chips used in several automotive applications such as infotainment, safety, and powertrain to customers in North America, Europe, and Asia. Additionally, Analog is working on developing smart and more fuel-efficient vehicles through its signal processing technology. Hence, the company is in good shape as it should benefit from growth in auto sales across the globe. 

LTE deployments pushing up communications
Communications is the next key driver for Analog. Its wireless infrastructure business is seeing robust growth because of LTE deployments and network upgrades in China and the U.S. In the last quarter, Analog saw strong demand from wireless infrastructure customers due to TD-LTE base station deployments in China.

This year, the prospects in this segment look healthier since telecom giant China Mobile is going all out to increase its footprint in the Middle Kingdom. China Mobile already built 200,000 base stations by December last year. This year, the telco is expected to add another 500,000 base stations as it looks to bring TD-LTE to 340 cities. In addition, China Mobile will also be launching several multimode and multi-frequency terminals.

The positives don't end here
Telecom companies will need to keep investing in their networks to make them efficient. This is where densification comes into play. Densification enables telcos to provide better services, especially in crowded areas, by replacing larger cell sites with a number of smaller cell sites. Telecom companies in the U.S. are already deploying small cells and Analog sees this as yet another growth opportunity.

Verizon, for example, started its small-cell roll out in February to deliver higher capacity and coverage. With this move, Big Red is trying to improve network coverage in hard-to-reach areas and high-traffic regions. Verizon completed its LTE roll out last year, covering more than 500 markets, and its latest initiative highlights the fact that capital spending by telcos won't stop even after the deployment is complete. So, Analog should continue seeing a steady stream of orders in its communications segment.

On the industrial side, Analog Devices is keeping inventories lean in its distribution channels. The beginning of inventory restocking by customers should ideally result in stronger orders going forward. This is exactly what Analog's management expects as the industrial segment is expected to grow in the current quarter.

Final words
All in all, Analog Devices looks well-positioned for growth from all its business segments. In addition, Analog has an impressive 2.80% dividend yield, and an aggressive share repurchase program, which is another way to deliver shareholder value. The company has bounced back after issuing a weak outlook earlier in the year and now looks set for the future.

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