The tech sector could be in for a rough 2023, and the hardware space in particular is headed in the wrong direction. Tech researcher Gartner recently revised its outlook for 2023 global IT spending downward. It now anticipates growth of just 2.4%, compared to the 5.1% growth it forecast previously. Device sales account for much of this tempered optimism. After declining by an estimated 10.6% in 2022, Gartner expects tech hardware sales to fall another 5% in 2023.
Smartphones are one of these device types for which sales have been sinking like a stone. This has been bad news for connectivity chipmaker Skyworks Solutions (SWKS -1.29%). Its shares have tumbled by 22% since the start of 2022. And while it looks like there will be another couple of bleak quarters ahead for the smartphone market, Skyworks stock could still be a buy right now.
The bad news for Skyworks Solutions
Let's start by considering some developments that might be making people a bit nervous about Skyworks as an investment. For years, Apple has been its largest customer. Despite Skyworks' multiple efforts to diversify its customer base -- including the sizable acquisition of Silicon Labs' infrastructure and automotive segment back in 2021 -- Apple still holds sway over the company. In its fiscal 2023 first quarter, which ended Dec. 30, Skyworks said its top customer (Apple) accounted for a whopping 68% of total revenue, up from 63% the prior quarter.
Why is that an issue? Apple especially has developed a reputation for squeezing its suppliers. In recent years, it has been working hard to try and develop its own cellular modem to cut highly profitable Qualcomm out of the mix, and recent reports indicate Apple is trying to do the same with even more profitable chip giant Broadcom.
Thus far, Skyworks hasn't had to contend with losing its friendly relationship with Apple, but the tech giant's interest in bringing more of its component manufacturing in-house is a persistent risk to bear in mind.
Apple is a good ally to have... for now
Customer concentration risk aside, Apple isn't a terrible business partner these days. Sales of the iPhone and other Apple products are actually holding up quite well, while the Android smartphone ecosystem languishes. In its fiscal Q1, Skyworks' revenue was only down 12% year over year to $1.33 billion. Earnings per share were down 20% year over year, or down 18% on an adjusted basis. Qualcomm, heavily reliant on Android, fared far worse in its comparable quarter.
However, also similar to Qualcomm, Skyworks reported significant progress in one key financial metric during this smartphone downturn. Its free cash flow increased 46% year over year to $709 million last quarter. Although free cash flow can be volatile from one quarter to the next, that surge was a result of disciplined expense control. Skyworks is also still early on in the process of ramping up its manufacturing of chips for autos and other industrial applications (non-wireless connectivity chips) -- the Silicon Labs designs it purchased back in 2021 that are beginning to pay off.
Skyworks Solutions' stock is too cheap to ignore
After the quarterly update it delivered last week, Skyworks Solutions is trading for just 16 times trailing 12-month earnings, or 17 times free cash flow. For its fiscal Q2. The company anticipates another year-over-year revenue decline of 14% at the midpoint of guidance, and for adjusted EPS to fall 23%. The downturn wrought by falling smartphone sales should last through the summer of 2023 before growth resumes.
That's right, that annual decline in hardware sales mentioned at the beginning of this article is broadly expected to take place during the first half of 2023. After that, excess inventory in the tech device space should be normalized, paving the way for a resumption of growth in the back half of the year and into 2024.
Even during this difficult time, Skyworks remains highly profitable and is returning excess cash to shareholders. A new $2 billion stock repurchase program was announced (worth more than 10% of the current market cap), and the stock's dividend still yields 2.1% at the current share price. Mind the imperfections at Skyworks Solutions, but for investors looking for gradual growth and income, this stock still looks like a quality buy to me right now.
