Analog Devices (ADI -1.14%) has made a nice recovery since the March crash on the back of a turnaround in the broader stock market, but the chipmaker's comeback isn't backed by a robust financial performance.
The company had to pull its fiscal second-quarter guidance in the wake of the COVID-19 outbreak that spawned uncertainty with respect to demand and disrupted supply chains. The novel coronavirus pandemic compounded Analog Devices' problems as the company was already witnessing a cyclical downturn in the semiconductor business.
And now, the company's latest quarterly results and the accompanying guidance provide further evidence that a turnaround in its fortunes is still some way off. There are quite a few pointers why Analog Devices may be a risky bet despite a nice dividend. Let's take a look.
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Analog surpasses estimates, but there are no signs of a turnaround
Analog Devices' second-quarter revenue fell 14% year over year to $1.32 billion, while earnings fell to $1.08 per share from $1.36 per share in the prior-year period. The results were mixed from Wall Street's perspective as analysts were looking for $1.04 per share in earnings on $1.33 billion in revenue.
But investors shouldn't forget that Analog was originally expecting $1.35 billion in revenue before it pulled its guidance on account of the novel coronavirus pandemic. The company's margins also took a hit during the quarter. Adjusted gross margin fell 290 basis points, while the adjusted operating margin was down by 350 basis points over the year-ago quarter.
The third-quarter guidance isn't very promising, either. Analog forecasts $1.32 billion in revenue and adjusted earnings of $1.08 per share, down from the prior-year period's earnings of $1.26 per share and revenue of $1.48 billion.
As it turns out, Analog Devices is facing challenges across its different business segments. The company's automotive and communications businesses, which together account for 35% of the total revenue, were down 23% and 24% year over year, respectively.
Management points out that weak vehicle sales and suspension of manufacturing operations dented the automotive business last quarter, which isn't surprising as several automakers halted production to contain COVID-19. The bad news for Analog Devices on this front is that auto sales in 2020 are expected to decline 22%, according to IHS Markit.
Similarly, there are reports that the deployment of 5G networks may be delayed, creating a headwind for Analog Devices' communications business. CFO Prashanth Mahendra-Rajah admitted on the latest earnings conference call that its communications business "is and will remain lumpy" in the near term, though the deployment of 5G will lead to long-term recovery.
And finally, Analog Devices says that its industrial business -- accounting for 54% of the total revenue -- is facing weakness across the board, barring some pockets such as the healthcare vertical.
In all, Analog Devices' financial performance may not improve substantially in the near term thanks to the headwinds created by COVID-19.
Some more challenges
Management believes that Analog Devices will be able to withstand the short-term challenges thanks to its balance sheet and cash flow profile. The company finished the quarter with $800 million in cash and $5.6 billion of debt. It retired $300 million worth of debt during the quarter, but also put its share repurchase plan on a temporary hold as a precautionary measure.
Analog Devices says that it has $2 billion worth of liquidity (including a revolving credit facility) that should help it meet its dividend commitment this year and the debt maturing in January 2021. That's good news for investors, as several companies have either suspended or reduced their payouts to preserve cash.
Analog Devices sports a nice dividend yield of 2.33%, which may attract income-oriented investors since it has managed to sustain its payout during these uncertain times. But then, the company's payout ratio of 66% isn't what one would call conservative, especially considering that its cash flow and margins have been heading south over the past year.
ADI Free Cash Flow data by YCharts
Additionally, Analog stock isn't cheap right now. Its price-to-earnings ratio of nearly 33 is higher than the five-year-average multiple of 30. It may not be a good idea to go long Analog Devices at this valuation given the ongoing weakness in the business as well as the headwinds expected in the coming months. So, anyone looking to buy dividend stocks should look at other attractive options as Analog doesn't appear to be a solid bet right now.
