3 Key Takeaways From Analog Devices’ Q2 Results

Analog Devices' industrial and automotive strength overshadow concerns regarding Apple.

Harsh Chauhan
Harsh Chauhan
Jun 14, 2017 at 9:48PM
Technology and Telecom

Shares of Analog Devices (NASDAQ:ADI) shot up to multiyear highs after the company's second-quarter results blew past expectations. The analog semiconductor specialist was in hot water earlier this year after Rosenblatt Securities analyst Jun Zhang pointed out that it might lose its Force Touch spot in Apple's (NASDAQ:AAPL) next iPhone because of cost cuts at Cupertino.

But Analog's latest results and guidance have put any apprehensions to rest, as they have clearly boosted investor sentiment, thanks to the growing strength of its industrial and automotive businesses. Here's why I see both businesses as crucial to the company's long-term growth, along with its Apple account.

Image of Analog Devices' logo.

Image Source: Analog Devices

Industrial growth is going to hit a higher gear

Analog Devices gets 46% of its revenue from its Industrial segment by supplying chips for factory automation, instrumentation, healthcare, and aerospace applications. As it turns out, this business has been on a tear lately, recording a 20% year-over-year jump in revenue for the second quarter.

Investors can expect the industrial business to get even better as Analog Devices see stronger-than-seasonal growth in the ongoing quarter, thanks to the impressive uptake of its industrial solutions after the Linear Technology acquisition completed earlier this year.

This isn't surprising, as Linear is bringing a lot of value for Analog, given its expertise in making high-performance chips for the industrial and automotive markets. As it turns out, the design cycles are longer in these two industries, setting up Analog for long-term growth given the increasing semiconductor demand in these markets.

For instance, the industrial-automation market is going to get bigger in the long run as companies try to boost productivity and reduce wastage by implementing real-time analysis in their operations. This can only be achieved by integrating Internet of Things (IoT) capabilities into the machinery, which requires analog chips made by Analog Devices to process the signals between the devices.

IndustryARC pins the size of the factory-automation market at $221 billion in 2021, which is estimated to boost semiconductor demand in this space at a rate of 9.7% a year, as per an evaluation from PricewaterhouseCoopers. Analog Devices, therefore, is sitting on a substantial end-market opportunity that could give a nice push to its revenue in the long run.

A graphic showing a semiconductor.

Image source: Getty Images.

Automotive could become a big catalyst

Back in 2015, the automotive market consumed $7 billion worth of chips according to Reportlinker's estimates. However, the growing adoption of telematics, connectivity, and advanced driver-assistance systems (ADAS) will push up the semiconductor content per vehicle substantially.

In fact, automotive semiconductor leader NXP Semiconductors forecasts that the chip content in each vehicle is going to jump to an average of $374 in 2019, creating a $36 billion market opportunity for companies in this space. Analog Devices doesn't want to miss this gravy train, so it has been fast expanding its offerings in this space to grab a bigger share of the pie.

Earlier this year, Analog Devices launched a new radar-technology platform based on an advanced node manufacturing process as a part of its Drive360 automotive solution. The company used its existing expertise in ADAS and radar technology to come up with a solution that claims to reduce the time to market for automotive OEMs (original equipment manufacturers), while also lowering development costs.

What's more, Analog claims that the solution will give vehicles additional time to take evasive measures, thanks to faster signal processing. Therefore, the company's automotive business could gain stronger traction as its new solution finds its way into more vehicles.

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What about Apple?

Analog Devices CEO Vincent Roche avoided the elephant in the room in an interview with Barron's, stating that his company is counting on rapid growth in the industrial and automotive end markets and is not worried much about Apple. It looks like the CEO is sidestepping the concern regarding a potential loss of business at Apple, but Roche wouldn't have made a specific comment on this matter given the potential investor fallout.

But investors can get an idea as to where this business is heading by reading between the lines. Apple supplies 12% of Analog Devices' total revenue by using the latter's Force Touch solutions in its iPhones. Analog includes this revenue in its consumer business, which fell 24% sequentially in the second quarter.

Roche makes sense when he says that product life cycles in the consumer space are shorter than the other businesses, so there'll be periods of transition when the revenue takes a hit. However, Analog Devices forecasts modest sequential growth in this business during the third quarter, indicating that business might be picking up as Apple starts ramping up iPhone production.

Additionally, fellow Fool contributor Ashraf Eassa makes a valid point when he says that Apple is less likely to cut costs for the next iPhone given the premium nature of the device.

The Foolish bottom line

Analog investors can expect the company to retain its slot at Apple, which could give a strong boost to its financial performance in the latter half of the year, as Cupertino might substantially increase production. This should add to the potential financial gains from the company's automotive and industrial businesses, setting it up for more upside.