Manufacturer of analog chips, Analog Devices (NASDAQ:ADI) reported Q1 FY2023 results beating Wall St's expectations, with revenue up 21.1% year on year to $3.25 billion. On top of that, guidance for next quarter's revenue was surprisingly good, being $3.2 billion at the midpoint, 5.4% above what analysts were expecting. Analog Devices made a GAAP profit of $961.5 million, improving on its profit of $280.1 million, in the same quarter last year.
Analog Devices (ADI) Q1 FY2023 Highlights:
- Revenue: $3.25 billion vs analyst estimates of $3.15 billion (3.15% beat)
- EPS (non-GAAP): $2.75 vs analyst estimates of $2.60 (5.69% beat)
- Revenue guidance for Q2 2023 is $3.2 billion at the midpoint, above analyst estimates of $3.04 billion
- Free cash flow of $1.23 billion, up 45.6% from previous quarter
- Inventory Days Outstanding: 123, up from 115 previous quarter
- Gross Margin (GAAP): 65.4%, up from 62.3% 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 33.2% annually. And as you can see below, last year has been especially strong, with quarterly revenue growing from $2.68 billion to $3.25 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 decent quarter for Analog Devices as revenues grew 21.1%, topping analyst estimates by 3.15%. This marks 10 straight quarters of revenue growth, which means the current upcycle has had a good run, as a typical upcycle tends to be 8-10 quarters.
Analog Devices' appears to be headed for a downturn. While the company is guiding to growth of 7.67% YoY next quarter, analyst consensus sees 4.36% declines over the next twelve months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business 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 inventory days came in at 123, 13 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.
Analog Devices's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 65.4% in Q1, up 3 percentage points year on year.
Gross margins have been relatively stable over the last year, averaging 65.6%. Analog Devices's gross margins remain one of the highest in the semiconductor industry, driven by strong pricing power from its differentiated chips.
Analog Devices reported an operating margin of 51.1% in Q1, up 5.3 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending up over the last year, averaging 50.6%. Analog Devices's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.
Earnings, Cash & Competitive Moat
Wall St analysts are expecting earnings per share to decline 8.88% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Analog Devices's free cash flow came in at $1.23 billion in Q1, up 65.1% year on year.
Analog Devices has generated $4.26 billion in free cash flow over the last twelve months, translating to 33.9% of revenues. This is a great result; Analog Devices's free cash flow conversion was very high compared to most semiconductor companies, in the last year. This high cash conversion, if maintained, puts it in a great position to invest in new products, while also remaining resilient during industry down cycles.
Analog Devices has an average return on invested capital (ROIC) of just 9.51%, over the last 5 years. This is fairly low compared to many other semiconductor companies, and suggests the company will have to tie up a lot of capital to achieve significant profit growth..
Key Takeaways from Analog Devices's Q1 Results
Sporting a market capitalization of $92.4 billion, more than $1.67 billion in cash and with positive free cash flow over the last twelve months, we're confident that Analog Devices has the resources it needs to pursue a high growth business strategy.
We were impressed by the very optimistic revenue guidance Analog Devices provided for the next quarter. And we were also excited to see that earnings outperformed Wall St’s expectations. On the other hand, it was less good to see the inventory levels increase. Overall, we think this was still a really good quarter, that should leave shareholders feeling very positive. The company is up 3.04% on the results and currently trades at $188 per share.
Is Now The Time?
When considering Analog Devices, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. Although we have other favorites, we understand the arguments that Analog Devices is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been strong, over the last three years. And on top of that, 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 twelve months is 19.3x. 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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