The tech-heavy Nasdaq Composite has been reaching new highs in the past few days. An August jobs report that shows the economy still has a long way to go in its recovery is expected to result in the Federal Reserve delaying its bond tapering plans. This, in turn, will imply the continued availability of cheap capital for high-growth technology companies. Although the improved investor sentiment seems to be buoying many technology stocks, there remain several that are fundamentally strong but are trading at discount to their intrinsic value.
Dynatrace (DT 4.25%) and Skyworks Solutions (SWKS 0.01%) belong to the latter category, although that may not be the case for long. Both of these stocks are driven by robust secular tailwinds and have significant competitive advantages. With that in mind, retail investors keen on multiplying their wealth should consider adding these stocks to their portfolios in September.
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1. Dynatrace
Dynatrace's software platform specializes in providing dynamic observability, automation, and analytics solutions for multi-cloud environments. With the pandemic accelerating the pace of digital transformation, enterprises are increasingly shifting to multi-cloud environments, which involve several vendors as well as a hybrid cloud model entailing private cloud storage for sensitive workloads and public cloud storage for cost efficiency and scale. Enterprises are also adopting various cloud-native software technologies such as containers and microservices. All this means increasing complexity especially in mission-critical applications, which requires strong artificial intelligence-based multi-cloud monitoring capabilities for effective troubleshooting and optimization.
Dynatrace is well positioned to leverage this opportunity, considering it offers superior artificial intelligence-powered observability services compared to its peers according to Gartner, Forrester Research, and Information Services Group. The company estimates its total addressable market (TAM) opportunity to be more than $50 billion and annual recurring revenue for fiscal 2022 (ending March 31, 2022) to be in the range of $984 million to $996 million, suggesting there is significant runway left for Dynatrace.
Dynatrace's customer acquisition and cross-selling success are evident in its latest financials. The company's customer base reached over 3,000 at the end of the first quarter (ending June 30). The company is targeting an account base of 15,000 organizations, which together account for 70% of the global information technology spend. Currently, over 40% of its customer base uses more than three of its modules, and these customers generate an average annual recurring revenue (ARR) of over $500,000. The company has reported a net expansion rate over 120% (20% more is spent by the average existing customer as compared to the previous year) for 13 consecutive quarters.
Dynatrace's first-quarter ARR was up 37% year over year to $823 million, while the adjusted gross margin was a healthy 85%. Subscription-based revenue accounted for over 93% of the company's first-quarter total revenue of $209.74 million. This suggests high revenue visibility for the company. Dynatrace is also cash flow positive and profitable.
Although the company trades at 26 times trailing-12-month sales, it is still quite less expensive compared to the more famous competitor Datadog's trailing-12-month price-to-sales multiple of 55.6. Hence, against the backdrop of solid fundamentals, robust financials, and a chance of even more multiple expansion, Dynatrace can prove to be an attractive pick even at the current elevated valuation levels.
2. Skyworks Solutions
Skyworks Solutions specializes in designing and manufacturing analog semiconductor chips for a range of applications such as mobile communications, automotive, industrial, and Internet-of-Things (IoT) devices. Being a chip vendor to many key players in the 5G smartphone market, including Apple, Xiaomi, Oppo, and Vivo, the company is well-positioned to benefit from the 5G device upgrade cycle. According to Juniper Research, 5G smartphones will account for half of all smartphone sales revenue by 2025.
Additionally, increasing demand for better performance is resulting better semiconductor chip performance in the next generation of 5G smartphones. The company expects this trend to play a major role in driving demand in China, despite already having 80% penetration of 5G smartphones in the country.
In fiscal 2020 (ending Oct. 2, 2020), Apple accounted for 56% of Skyworks Solutions' net revenue. This can be considered a positive, considering that Apple plans to build 90 million next-generation iPhones in 2021, a year-over-year rise of 20%. But this also exposes the company to excessive business concentration risk.
To counter this challenge, the company has been diversifying into areas such as IoT solutions, including smart audio and Wi-Fi 6 and 6E as well as automotive and infrastructure markets. In July 2021, the company completed the acquisition of Silicon Laboratories' infrastructure and automotive business in an all-cash deal worth $2.75 billion. Skyworks Solutions also stands to benefit from the government's planned $65 billion investment in U.S. broadband infrastructure, as part of the $1 trillion bipartisan infrastructure package.
The ongoing global chip shortage has proven a major challenge for Skyworks Solutions. Although the company operates its own fabs, it is being affected by the drop in demand from customers who are finding it difficult to source other components that are required to manufacture products. Yet the company is better-positioned than its fabless peers to take advantage of the rising semiconductor prices.
In the third quarter (ending July 2), revenue soared 52% year over year to $1.12 billion, while adjusted diluted earnings per share were up 72% year over year to $2.15. Skyworks Solutions is guiding for double-digit sequential revenue growth for both its mobile and non-mobile products businesses in the fourth quarter (ending Oct. 2).
SWKS PS Ratio (Forward) data by YCharts
Despite a solid secular growth story and improving financials, Skyworks Solutions is trading at 5.8 times forward sales, which is significantly lower than its valuation in the previous year. The company also pays a dividend yield of 1.22% (as of Sept. 7), and management sees more scope in further improving dividends. Against this backdrop, this semiconductor player can wind up being a huge winner in the coming months.
