Where Will Skyworks Solutions Be in 5 Years?

Skyworks Solutions (SWKS 2.08%) has been at the forefront of the smartphone boom over the last decade-plus thanks, in large part, to its outsized reliance on Apple's (AAPL 0.51%) iPhone. But for the last couple of years, smartphone sales have tapered off. That's okay, though.

A new phone upgrade cycle driven by 5G is getting underway, and Skyworks is only just beginning to gain positive traction with its connectivity chip portfolio outside of the smartphone industry. The next five years look especially promising for this top semiconductor stock.

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To 5G, and beyond...

From the late 2000s to today, there has been no greater tech hardware wave to ride than Apple's -- and Skyworks Solutions is in great financial shape as a result. In fact, in recent quarters the company has implied that roughly half of its revenue is still derived from Apple. In the fourth quarter of fiscal 2020 (the three months ended Oct. 2, 2020), Skyworks management said some 69% of sales came specifically from the smartphone industry.  

In the last couple of years, though, that hasn't been the best of industries to be reliant on. Sure, smartphones are a modern staple and providing 4G and WiFi connectivity chips has been a stable source of revenue. But between effects from the U.S.-China trade war and consumers holding onto phones for close to three years now, sales growth has stalled out for Skyworks.

Data by YCharts.

However, smartphone sales growth may be starting to show signs of life again thanks to 5G mobile networks and the device upgrade needed to take advantage of the faster service. Skyworks thinks 5G-enabled phone shipments will increase to 15% of the total in 2020, up from just 1% in 2019. That figure will increase steadily in the coming years as 5G availability expands and more consumers buy a new phone. In fact, this upgrade cycle recently helped Skyworks return to year-over-year growth in the final quarter of its 2020 fiscal year, and the company forecasts another period of growth to kick-off 2021.  

A best-in-class R&D department

Developing new tech and services is a critical function of semiconductor companies. Over time, demand from end markets changes, so companies constantly need to invest in new chip designs to stay relevant. More importantly, all hardware technology loses value over time. It gets commoditized by competitors and replaced with more powerful computing equipment. This, in part, explains what happened to the smartphone super-cycle that put Skyworks on the map in the 2010s in the first place, only to later stall out.

Eventually, the same thing will happen to 5G chips -- although this time around, Skyworks' portfolio of gear is even more comprehensive and includes hardware for 5G infrastructure itself in addition to the chips that enable a phone or other device to connect to the network. Still, in the early stages of development, 5G should provide a multi-year run higher for Skyworks Solutions' revenue. After a long drought, 5G phones and infrastructure equipment are great news for shareholders of the connectivity chip leader. However, there's much more going on here than 5G -- and that's a very good thing.

Skyworks has long been at work developing other important technology to take advantage of mobility outside of the smartphone world. This includes WiFi 6 chips and other network radios enabling industrial equipment, healthcare devices, space and defense-grade chips, automotive, and other various consumer goods -- collectively called the "Internet of Things." During the final quarter of 2020, these broad markets made up 31% of Skyworks' revenue and grew 30% on a quarter-over-quarter sequential basis. The chip designer has been making steady progress on this front for a while, and in five years' time, I think it will represent an even larger share of the business overall.

A sampling of some of the devices Skyworks is powering includes Facebook's Oculus Quest 2 virtual reality device, wireless point of sale systems for Square, Amazon's eero WiFi devices, Netgear WiFi 6 routers, and wireless audio and gaming headsets for Logitech, to name just a few. These broad-based end markets are growing in importance as connectivity tech improves and renders older wired solutions irrelevant -- but there's plenty of room for improvement and expansion.

However, development in these various markets outside of phones is only just beginning to pay off. Skyworks' return on invested capital has averaged well into the double-digit percentages for years, but it hasn't helped it buck the cyclical slowdown in phones until just recently. But with its "broad markets" portfolio approaching a third of revenue and the 5G wave getting underway, this best-in-class R&D department will start to yield returns for shareholders.

Data by YCharts.

In the years ahead, wireless connectivity growth could come from various sources outside of 5G, but whichever direction the industry turns, Skyworks will be there to meet demand. Besides robust return on investment, the company generated $806 million in free cash flow (revenue less cash operating and capital expenses) in 2020 -- good for a free cash flow margin of 24% -- and had $980 million in cash and short-term equivalents and zero debt on its balance sheet. Now that's a winning combination if enduring technology growth is what you're after. If you believe wireless connectivity is the future, Skyworks Solutions' stock is the place to start.