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This 5G Stock Should Be on Your Radar Despite Near-Term Challenges

By Harsh Chauhan - Apr 13, 2020 at 10:01AM

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Near-term weakness in smartphone sales will weigh on this chipmaker, but investors should look at the bigger picture.

The novel coronavirus pandemic has sent the stock market packing in 2020 as Wall Street braces for a severe economic fallout on account of the lockdowns imposed by several countries across the globe. But one firm believes that the worst may be behind us already.

According to London-based economic research consultancy Capital Economics, Wall Street may have already priced in a substantial portion of the bad news arising from the COVID-19 outbreak. The firm believes that the coronavirus-induced recession will be short-lived, and the turnaround will be quick.

However, investors shouldn't expect a turnaround right away as things could get worse before they get better. Also, it is difficult to say with certainty as to when the market will start recovering in a sustainable manner. Despite those uncertainties, now may be a good time to add potential growth stocks to the watchlist that have the potential to take off once things return to normal.

Human interface hardware and software developer Synaptics (SYNA -3.38%) is one such candidate that looked on top of its game coming into 2020 before the COVID-19 pandemic rattled the markets.

Person holding a 5G smartphone.

Image source: Getty Images.

Short-term headwinds ahead for Synaptics

Synaptics' business hit a bottom in the second quarter of fiscal 2020. The company's revenue for the quarter was down 9% annually. But the mid-point of its third-quarter guidance points toward a low single-digit revenue jump.

Not surprisingly, Synaptics stock soared as the company had finally turned a corner after years of financial underperformance before the novel coronavirus entered the fray.

SYNA Chart

SYNA data by YCharts

The stock's crash isn't surprising as Synaptics' reliance on the smartphone business for 52% of its revenue means that its outlook in the coming quarters isn't going to be pretty. Strategy Analytics estimates that global smartphone shipments were down a whopping 38% year-over-year to 61.8 million units in February 2020.

This record plunge was a result of supply chain disruptions and collapsing demand in Asia because of the COVID-19 pandemic. Now that the virus has spread beyond Asia to hotspots in Europe and North America, Strategy predicts that the smartphone market is going to remain in limbo. Buyers may not be willing to spare money on a new device, and that's going to hit Synaptics' biggest source of revenue.

What's more, Synaptics may now have to wait longer for its iPhone catalyst. Reports of the chipmaker winning a spot to supply OLED display sensors to Apple were doing the rounds earlier this year. That could have been the case as Synaptics claimed that it was winning contracts for its OLED display sensors from Tier 1 original equipment manufacturers (OEMs).

But that potential catalyst will have to be put on the back burner for now as iPhone sales are expected to take a beating in the wake of the COVID-19 pandemic. There have been reports of Apple delaying the launch of its 5G-capable smartphone, as Apple management assesses the impact of the novel coronavirus outbreak on demand.

So, the picture in Synaptics' smartphone business is shaky right now. The situation will continue to remain grim until smartphone shipments pick up the pace, and that's unlikely to happen in the near term.

CCS Insights predicts that smartphone shipments could tumble 13% in 2020 to a decade-low figure of 1.57 billion units. However, smartphone sales are expected to bounce back significantly in 2021 with shipments expected to jump 12% on the back of 5G strength. So, Synaptics investors may have to wait for some time before its mobile business gets back on track.

But the good part is that the smartphone weakness may be mitigated by strength in Synaptics' PC business.

The silver linings

Synaptics gets 24% of its revenue from the PC business, which might get a shot in the arm in the wake of the COVID-19 outbreak. That's because sales of PCs are reportedly rising as more people take to telecommuting to follow social distancing measures that are critical to contain the spread.

Market research firm NPD Group points out that sales of laptops were up 10% in the first two weeks of March. Business-to-business (B2B) notebook sales increased a whopping 30% annually in the last week of February and 50% in the first two weeks of March. As such, there's a good chance that Synaptics' PC business might see a bump in orders thanks to an increase in demand for its touch controllers.

There is a possibility that the PC business could help Synaptics avoid a hard landing that the drop in its smartphone business might cause. This is something that could keep investors in good spirits when the company releases its quarterly report next month.

Another thing to like about Synaptics is its valuation. The stock currently trades at 52 times earnings, which may seem expensive at first. But the good part is that its earnings multiple is much lower than the five-year average price-to-earnings (P/E) ratio of 88.

The forward P/E of 12 looks much more reasonable, making Synaptics a stock worth watching if it manages to win over Wall Street with a strong showing in the PC business.

But if the chipmaker's performance falls short of expectations, it may be a blessing in disguise. Savvy investors could get an opportunity to buy Synaptics stock at a potentially lower valuation in the coming months and take advantage of the 5G smartphone opportunity in the long run.

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