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A Recovering Communications Business Is Making This Company Better

By Harsh Chauhan - Sep 4, 2013 at 8:45AM

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Analog Devices is gradually getting better.

Chipmaker Analog Devices (ADI 2.85%) has had a sluggish year so far, disappointing investors consistently on its outlook and delivering mixed results.

The company, which makes chips for industrial, automotive, communications, and consumer end markets, recently declared its third-quarter results, and its outlook was once again behind expectations. Analog Devices expects $675 million to $700 million in revenue for the ongoing quarter, which is below the Street estimate of $697 million at the mid-point.

This explains why Analog Devices is up just 12% this year while the PHLX Semiconductor index is up 22%. However, despite the poor guidance, Analog Devices is seeing improvements in its various end markets, and its order rates are on the rise. Management stated in the previous conference call that the book-to-bill ratio for the third-quarter was one, and total orders were better than the preceding quarter.

Rebound in progress
Most importantly, Analog's communications infrastructure business, which had been sluggish so far this year, increased 12% from the previous quarter. The buildout of the 3G TD-SCDMA network in China and rollout of 4G LTE networks in the U.S. finally pulled Analog's communications business out of a slump .

Going forward, the company expects this segment to do even better on the back of "densification" of 4G LTE networks in the U.S. and deployment in China. Densification involves replacing larger cell sites with a number of smaller cell sites, allowing telecom carriers to support more users and provide better services, especially in crowded areas.

For instance, through its Project Velocity IP program, telecom major AT&T (T 1.84%) has been aggressively deploying large and small cell sites as a part of its three-year plan to enhance its networks in different markets.

Ma Bell's LTE coverage has been increasing at a brisk pace and the carrier is focused on covering 300 million customers with its LTE service by the end of next year . Also, as other players such as Sprint, which will be spending $16 billion in the next two years to upgrade its infrastructure, deploy their own LTE networks, Analog Devices should continue witnessing growth in its communications business.

Another major driver should come out of China, where China Mobile (CHL) is set to deploy the nation's first 4G network . The world's largest telecom company by subscribers recently awarded contracts worth nearly $3.2 billion as it sets out to build 207,000 base stations in 31 provinces. According to China Daily, out of China Mobile's expected $30.5 billion capital spending this year, around 50% will be allocated to 4G LTE .

Analog Devices is optimistic about the future of its communications business and activity in the end market suggests that there are enough opportunities for growth.

All-around growth
With the communications infrastructure segment looking set for a rebound, Analog Devices will be in a better position to grow since its industrial and automotive businesses have already been doing well. The industrial semiconductor market has been doing well and according to IHS, sales of industrial electronics chips increased slightly in the first quarter to $7.71 billion.

The research firm stated that chipmakers are seeing leaner inventories on the back of strong orders from customers, and Analog Devices' management also echoed the same sentiment over the previous conference call.

In the automotive market as well, the company expects the proliferation of advanced safety features and use of higher electronic content for various applications such as in-car infotainment to increase its addressable market.

Final words
The weak performance of Analog Devices' communications business has weighed on the company so far this year, but with things looking up in the segment, the company would probably do better going forward.

With a trailing P/E of 22, Analog Devices trades slightly below the industry average of 23 , so investors won't be paying a very high price for the stock. Moreover, a decent dividend yield of 2.90% and a diversified business are some more reasons why Analog Devices looks like a good investment.

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