Manufacturer of analog chips, Analog Devices (NASDAQ:ADI) reported results in line with analysts' expectations in Q4 FY2023, with revenue down 16.4% year on year to $2.72 billion. On the other hand, next quarter's revenue guidance of $2.5 billion was less impressive, coming in 7.3% below analysts' estimates. Turning to EPS, Analog Devices made a non-GAAP profit of $2.01 per share, down from its profit of $2.73 per share in the same quarter last year.
Analog Devices (ADI) Q4 FY2023 Highlights:
- Revenue: $2.72 billion vs analyst estimates of $2.72 billion (small beat)
- EPS (non-GAAP): $2.01 vs analyst expectations of $2.02 (small miss)
- Revenue Guidance for Q1 2024 is $2.5 billion at the midpoint, below analyst estimates of $2.70 billion
- EPS (non-GAAP) Guidance for Q1 2024 is $1.70 at the midpoint, below analyst estimates of $1.90
- Free Cash Flow of $710.9 million, down 13.1% from the previous quarter
- Inventory Days Outstanding: 140, up from 140 in the previous quarter
- Gross Margin (GAAP): 60.6%, down from 66% 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).Analog Semiconductors
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.
Sales Growth
Analog Devices's revenue growth over the last three years has been very strong, averaging 33.3% annually. But as you can see below, its revenue declined from $3.25 billion in the same quarter last year to $2.72 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).
This was a slow quarter for the company as its revenue dropped 16.4% year on year, in line with analysts' estimates. This could mean that the current downcycle is deepening.
Analog Devices's revenue growth has decelerated over the last three quarters and its management team projects growth to turn negative next quarter. As such, the company is guiding for a 23.1% year-on-year revenue decline while analysts are expecting a 10.4% drop over the next 12 months.
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 25 days above its five-year average, suggesting that the company's inventory levels are higher than what we've seen in the past.
Pricing Power
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 60.6% in Q4, down 5.4 percentage points year on year.
Despite declining over the past year, Analog Devices still retains robust gross margins, averaging 63.9%. These attractive unit economics point to its potent and competitive product offering, pricing power, and efficient inventory management.
Profitability
Analog Devices reported an operating margin of 44.7% in Q4, down 6.4 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 stable over the last year, averaging 48.7%. Furthermore, the company's margins are higher than most in the semiconductor industry, showcasing how efficiently the business is managed.
Earnings, Cash & Competitive Moat
Wall Street expects earnings per share to decline 17.1% 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 $710.9 million in Q4, down 15.9% year on year.
As you can see above, Analog Devices produced $3.56 billion in free cash flow over the last 12 months, an eye-popping 28.8% 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 9.1%. This suggests it struggled to find compelling reinvestment opportunities within the business.
Key Takeaways from Analog Devices's Q4 Results
Sporting a market capitalization of $91.6 billion, more than $958.1 million in cash on hand, and positive free cash flow over the last 12 months, we believe that Analog Devices is attractively positioned to invest in growth.
While the quarter itself was ok, the big disappointment was around next quarter's guidance. The company's outlook for both revenue and adjusted EPS came in well below expectations. The company is down 2.9% on the results and currently trades at $178.5 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.
Although we have other favorites, we understand the arguments that Analog Devices isn't a bad business. We'd expect growth rates to moderate from here, but its impressive revenue growth over the last three years suggests it's increasing its market share. And while its relatively low ROIC suggests it has struggled to grow profits historically, the good news is its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion.
Analog Devices's price-to-earnings ratio based on the next 12 months is 22.6x. In the end, beauty is in the eye of the beholder. While Analog Devices wouldn't be our first pick, if you like the business, the shares are trading at a pretty interesting price point right now.
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