NXP Semiconductors (NASDAQ:NXPI) is not exactly crushing the market in 2016. This year, shares of the Netherlands-based mixed-signal chip maker have gained a mere 7.5%. That's in line with the PHLX Semiconductor index, and just ahead of the S&P 500 market benchmark's 4% return.
Why is NXP hanging back at these mellow returns in spite of the company's fantastic future prospects? Let's have a look.
The story so far
As the year started, NXP was fresh off of its merger with Texas-based rival Freescale Semiconductor. Nervous investors were hoping for a big revenue jump from this game-changing merger, but weak demand across the industrial chip industry led to a disappointing fourth-quarter report. At this point, NXP shares were down as much as 24% year to date.
Analysts saw this low point as a buy-in opportunity and started slapping "buy" labels on NXP's stock. Today, the average analyst price target stands at $110 per share, which is 21% above current share prices. The lowest of the 24 broker targets sits at $94 per share. In short, every analyst agrees that NXP shares are undervalued today.
Of course, analysts don't nail every prediction. In fact, they are often downright wrong. And don't forget that their companies often do business with the companies they cover, raising the uncomfortable possibility of conflicting interests.
From a more objective point of view, NXP still looks undervalued. Shares are trading at deep discounts to the broader chip industry whether you're looking at price to earnings, price to book value, or price to free cash flows. On top of that, NXP's operating margins and returns on equity are not only above industry averages -- they are among the very highest scores you'll find in this sector.
We've seen NXP waver and then recover in 2016, but there's still plenty of headroom for strong share price gains. What will it take to lift NXP stock to the level its business deserves?
Well, the Freescale merger is still happening. Keeping this progress on track is of key importance to NXP's management. Beyond the obvious aim of delivering on promised post-merger cost savings, the company is also building synergies and cross-pollination relationships that will take NXP to the next level. We are looking at the birth of a giant in the connected and self-driving car industries, where Freescale was a leader and NXP itself brought some fresh perspectives to the table.
The business growth of the next decade is being shaped right now. It's not an easy process, and management can absolutely botch it. In fact, investors seem to be betting on that outcome today. That's why NXP shares haven't been beating the market in 2016.
The second half could see the start of a larger rebound, but only if the Freescale integration continues to deliver on its promises. The slightest hiccup might delay the valuation ratio expansion into 2017 and beyond.
Meanwhile, the stock looks very affordable if you believe in NXP as a long-term play on automotive computing. You'll also have to trust that management has the chops to execute on these goals. So far, I've seen no signs of impending failure.
This stock is on my short list for the next time I'm ready to start a new position. Maybe it belongs on yours, too.