RF component supplier RF Micro Devices (NASDAQ: RFMD) has had a very good year so far. The stock has more than doubled, with shares rising from around $5 at the beginning of the year to nearly $12 today. The company's profitability has greatly improved, with margins surging during the most recent quarter, and strong guidance suggests that this trend will continue. Lastly, the announced merger with TriQuint, set to close later this year, promises to make the combined company more competitive in a difficult market.
Given all of these positive developments, is it time to buy shares of RF Micro Devices?
An inconsistent past
RF Micro's recent performance has been exceptional. During the company's fiscal first quarter, revenue rose by 23.6% year-over-year, accompanied by an expanding gross margin and a dramatic swing to profitability. Operating margin was a strong 14.6%, a vast improvement over the slight loss reported during the same quarter last year.
While guidance points to another strong quarter ahead, no doubt thanks in part to the launch of new iPhones from Apple, RF Micro has been unable to sustain either revenue growth or profitability during the past decade. This inconsistency is despite the rapid growth of smartphone shipments over the past few years, and it brings into question the argument that growth of the smartphone market will lead to growth for RF Micro.
RFMD Revenue (Annual) data by YCharts
In fiscal 2011, which ended in March of that year, RF Micro managed $1.05 billion of revenue. Revenue was lower in fiscal 2012 and 2013, finally rising above that peak value in fiscal 2014. Meanwhile, global smartphone shipments rose from about 300 million in 2010 to over 1 billion in 2013.
Without any significant competitive advantages, there's little reason to believe that RF Micro's performance during the most recent quarter will be sustainable in the long term. There's also little reason to believe that continued growth in smartphone shipments will lead to revenue growth of the same magnitude for RF Micro, since that hasn't been the story over the past few years. The RF component market is competitive, with RF Micro battling rivals like Skyworks Solutions and Qualcomm, and this competition makes it hard to believe that double-digit operating margins are the new norm for RF Micro, especially given its spotty performance in the past.
RF Micro is merging with TriQuint in an effort to increase its scale. But much like RF Micro, TriQuint has had an inconsistent decade when it comes to profitability, and the company has lost money in each of the past two years on a GAAP basis. Whether the combined company will be any more consistent going forward than the constituent companies have been in the past is anyone's guess.
Valuation
Despite RF Micro's inconsistency, an attractive valuation could still make the stock a buy. Unfortunately, after the strong performance so far this year, RF Micro's stock is priced at levels that don't reflect the risk that the company's recent profitability may be unsustainable.
If we assume that RF Micro can manage a 15% operating margin going forward, this would lead to operating income of about $175 million based on revenue over the past 12 months. RF Micro's market capitalization is currently $3.4 billion, putting the stock at 19.5 times this hypothetical operating income and roughly 31 times hypothetical earnings, using a 35% tax rate.
Even if a 15% operating margin was a sure thing, the current stock price bakes in growth assumptions that seem unrealistic given the past performance of the company. And anything short of 15% would lead to the current stock price being far too high to be able to justify. The merger with TriQuint does change things a bit, but while RF Micro expects the transaction to be accretive to non-GAAP earnings in the first full year, GAAP earnings will likely be a different story.
The bottom line
I don't see a good reason to believe that RF Micro's recent profitability will be sustainable, given how inconsistent the company has been in the past. The current stock price is ignoring this risk, and in fact is pricing in rapid growth to boot. Is it possible that, going forward, RF Micro will be far more profitable and consistent than in the past? Sure. But it seems like more of a gamble than an investment, and for that reason, it's not time to buy RF Micro stock.
