This article about NXPI's Q2 earnings report was originally published on Aug. 12, 2015. Click here for a fool.com article on the company's Q3 earnings report in October, or check out all of the Fool's coverage on NXP Semiconductors here.
NXP Semiconductors (NASDAQ:NXPI) is clearly benefiting from the Internet of Things trend and the increasing semiconductor content in all of our devices. The company put up better-than-expected earnings on July 28, sending the stock higher almost 7% the next day. But a closer look at the top line, along with comments from management, reveals a few concerns about growth going forward. Combined with its rich valuation, this news makes NXPI much less attractive for investors.
First, the good
NXP Semiconductors had a solid quarter by almost all accounts. Revenue grew 12% year over year, and margins increased, especially on the operating side. Further, the company is on track with the Freescale Semiconductor (NYSE:FSL) acquisition and is even ahead of schedule in leverage reduction.
The company is getting its chips into high-growth areas such as contactless mobile payments, the Internet of Things, mobile-phone charging, increased cellular data consumption, and LED lighting. The two business segments that cover these products grew 39% and 29% year over year, very impressive numbers.
Some chinks in the armor
On the downside, those two high-growth segments are less than 40% of NXP's revenue. The other three segments are growing much more slowly, and more worrisome is management's expectations that growth in these segments will be flat to the mid-single digits at best. That's not to say NXP couldn't take more share and grow faster than the overall market, but it sure is harder without an industry tailwind.
The past quarter's revenue was in line with expectations, but guidance for the next quarter was a little lighter than what Wall Street analysts were expecting. In the conference call the following morning, management said, "Conversations with both customers and channel partners reflect an increased sense of caution," and "I think people have been a little bit more conservative in their view of the market, and there does appear to be a little bit of nervousness." Later in the question-and-answer session, management continued to make references to the "weaker macro backdrop."
Not a worry, except ...
Normally one-quarter of these comments and a little lighter guidance wouldn't be a huge problem, except when you examine NXP's valuation and notice the market is certainly counting on a lot of continued growth. The EV/EBITDA ratio for NXPI is hanging around a lofty 24, higher than it's ever been and much higher than the industry average.
In addition, gross and operating margins are at their highest levels ever -- and they're also some of the highest in the industry. Again, this news in itself is a great thing, and hats off to NXP for the achievement. But let's not forget that NXP is still in the semiconductor industry, which tends to be very cyclical. Management also noted in the call that it was able to keep operating costs down by not hiring ahead of the Freescale integration; so the surprisingly good margins this quarter could be somewhat temporary.
The Freescale integration will be good for the company in the long run, fortifying and consolidating its position in the industry. But a large integration like this almost always has a few hiccups and unexpected costs along the way.
None of this is to say holders of NXP stock should sell immediately. Rather, if investors have been fortunate to have enjoyed this great ride so far, it might be time to take some profits in light of the valuation, potentially slowing growth and the integration risks ahead. For those looking to get into NXP, it would be prudent to wait for a more reasonable price, especially as the stock doesn't pay a dividend, making a long-term buy-and-hold less attractive.
Chris Kuiper has no position in any stocks mentioned. The Motley Fool owns shares of and recommends NXP Semiconductors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.