Manufacturer of analog chips, Analog Devices (NASDAQ:ADI) missed analysts' expectations in Q3 FY2023, with revenue down 1.07% year on year to $3.08 billion. The company's full-year revenue and EPS guidance also fell short of Wall Street's estimates. Analog Devices made a GAAP profit of $877 million, improving from its profit of $749 million in the same quarter last year.
Analog Devices (ADI) Q3 FY2023 Highlights:
- Revenue: $3.08 billion vs analyst estimates of $3.1 billion (0.9% miss)
- EPS (non-GAAP): $2.49 vs analyst expectations of $2.52 (1.37% miss)
- Revenue Guidance for Q4 2023 is $2.7 billion at the midpoint, below analyst estimates of $3.03 billion
- Free Cash Flow of $817.9 million, similar to the previous quarter
- Inventory Days Outstanding: 140, up from 134 in the previous quarter
- Gross Margin (GAAP): 63.8%, down from 65.7% in the same quarter last year
Founded by two MIT graduates, Ray Stata and Matthew Lorber in 1965, Analog Devices (NASDAQ:ADI) is one of the largest providers of high performance analog integrated circuits used mainly in industrial end markets, along with communications, autos, and consumer devices.
ADI is one of the largest analog chip makers, and is a major supplier of converters, amplifiers, sensors, and digital signal processing chips used by over hundred thousand customers.
ADI has been an active consolidator in the space, acquiring Hittite Microwave in 2014 which added radio frequency or RF chips to its portfolio, Linear Technology in 2017 which bolstered ADI’s power management chips. In 2021 it closed its $21 billion acquisition of Maxim Integrated, which increased ADI’s exposure to faster growing automotive and data center end markets.Analog Devices’ peers and competitors include Texas Instruments (NASDAQ: TXN), Skyworks (NASDAQ:SWKS), Infineon (XTRA:IFX), NXP Semiconductors NV (NASDAQ:NXPI), ON Semi (NASDAQ:ON), Marvell Technology (NASDAQ:MRVL), and Microchip (NASDAQ:MCHP).
Longer manufacturing duration allows analog chip makers to generate greater efficiencies, leading to structurally higher gross margins than their fabless digital peers. The downside of vertical integration is that cyclicality can be more pronounced for analog chipmakers, as capacity utilization upsides work in reverse during down periods.
Analog Devices's revenue growth over the last three years has been very strong, averaging 35.2% annually. But as you can see below, its revenue declined from $3.11 billion in the same quarter last year to $3.08 billion. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
Analog Devices had a difficult quarter as revenue dropped 1.07% year on year, missing analysts' estimates by 0.9%.
Analog Devices's revenue inverted from positive to negative growth this quarter, which was unfortunate to see. Looking ahead to the next quarter, the company's management team forecasts a 16.9% year-on-year revenue decline. Analysts seem to agree that the poor performance will continue, as their estimates for the next 12 months call for a 5.32% drop in revenue.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, Analog Devices's DIO came in at 140, which is 26 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Analog Devices's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 63.8% in Q3, down 1.9 percentage points year on year.
Gross margins have been trending up over the last year, averaging 65.2%. These are some of the best margins in the semiconductor sector, driven by strong pricing power from its differentiated, value-add products.
Analog Devices reported an operating margin of 47.8% in Q3, down 2.3 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Analog Devices's operating margins have been trending up over the last year, averaging 50.3%. On top of that, the company's margins are some of the highest in the semiconductor industry, driven by its highly efficient operating model and economies of scale.
Earnings, Cash & Competitive Moat
Wall Street expects earnings per share to decline 9.93% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Analog Devices's free cash flow came in at $817.9 million in Q3, down 24.5% year on year.
As you can see above, Analog Devices produced $3.69 billion in free cash flow over the last 12 months, an eye-popping 28.7% of revenue. This is a great result; Analog Devices's free cash flow conversion places it among the best semiconductor companies and, if sustainable, puts the company in an advantageous position to invest in new products while remaining resilient during industry downturns.
Over the last five years, Analog Devices has reported an average return on invested capital (ROIC) of just 9.7%. This suggests it struggled to find compelling reinvestment opportunities within the business.
Key Takeaways from Analog Devices's Q3 Results
With a market capitalization of $88.6 billion, a $1.15 billion cash balance, and positive free cash flow over the last 12 months, we're confident that Analog Devices has the resources needed to pursue a high-growth business strategy.
We struggled to find many strong positives in these results. Analog Devices's revenue missed Wall Street's estimates, its revenue guidance for next quarter underwhelmed, and it lowered its margin expectations, partly due to customer inventory adjustments it had to make. CEO Vincent Roche noted that from his point of view, economic conditions are deteriorating. Overall, this was a tough quarter for Analog Devices. The company is down 6.77% on the results and currently trades at $164.74 per share.
Is Now The Time?
Analog Devices may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. We think Analog Devices is a solid business. We'd expect growth rates to moderate from here, but its superb revenue growth implys that it's winning market share over the last three years. And while its relatively low ROIC suggests suboptimal profitability prospects, the good news is its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion and its impressive operating margins indicate a highly efficient business model.
Analog Devices's price-to-earnings ratio based on the next 12 months is 18.2x. There are definitely things to like about Analog Devices and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.
Wall Street analysts covering the company had a one year price target of $206.4 per share right before these results, implying that they saw upside in buying Analog Devices even in the short term.
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