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Analog Devices (NASDAQ:ADI) Reports Upbeat Q2, Guides For Strong Sales Next Quarter


Full Report / May 18, 2022
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Manufacturer of analog chips, Analog Devices (NASDAQ:ADI) announced better-than-expected results in the Q2 FY2022 quarter, with revenue up 78.8% year on year to $2.97 billion. On top of that, guidance for next quarter's revenue was surprisingly good, being $3.05 billion at the midpoint, 5.39% above what analysts were expecting. Analog Devices made a GAAP profit of $783.2 million, improving on its profit of $422.9 million, in the same quarter last year.

Analog Devices (ADI) Q2 FY2022 Highlights:

  • Revenue: $2.97 billion vs analyst estimates of $1.09 billion (4.81% beat)
  • EPS (non-GAAP): $2.40 vs analyst estimates of $2.11 (13.6% beat)
  • Revenue guidance for Q3 2022 is $3.05 billion at the midpoint, above analyst estimates of $2.89 billion
  • Free cash flow of $1.1 billion, up 48% from previous quarter
  • Inventory Days Outstanding: 95, up from 69 previous quarter
  • Gross Margin (GAAP): 65.4%, down from 68.4% 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. Read More The semiconductor industry is broadly divided into analog and digital semiconductors. Digital chips are what most people think of as the brains of almost every electronic device. Their primary purpose is to either store (memory chips) or process (CPUs/GPUs) data. By comparison, analog chips regulate real world signals, such as temperature, speed, sound, or electrical current, converting them into a stream of digital data that can be processed by digital semiconductors. Analog semiconductors are also used to manage power in any electronic device; they convert, store and distribute the electrical energy that comes from a battery or wall plug. Analog chips are found everywhere from household appliances like refrigerators or washing machines, to smartphones, cars and factory production lines.

Sales Growth

Analog Devices's revenue growth over the last three years has been solid, averaging 19.5% annually. But as you can see below, last year has been stronger for the company due to the acquisition, growing from quarterly revenue of $1.66 billion to $2.97 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 Total Revenue

This was a good quarter for Analog Devices with 78.8% revenue growth, beating analyst estimates by 4.81%. This marks 7 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.

However, Analog Devices believes the growth is set to continue, and is guiding for revenue to grow 73.4% YoY next quarter, and Wall St analysts are estimating growth 24.8% 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.

Analog Devices Inventory Days Outstanding

This quarter, Analog Devices’s inventory days came in at 95, 10 days below the five year average, showing that despite the recent increase there is no indication of an excessive inventory buildup at the moment.

Pricing Power

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 Q2, down 3 percentage points year on year.

Analog Devices Gross Margin (GAAP)

Despite declining over the past year, Analog Devices still retains strong gross margins, averaging 58.7%, pointing to a still potent competitive offering, pricing power, and solid inventory management.

Profitability

Analog Devices reported an operating margin of 50.3% in Q2, up 8.6 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.

Analog Devices Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 45.6%. 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

Analysts covering the company are expecting earnings per share to grow 15.1% 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 $1.1 billion in Q2, up 62.8% year on year.

Analog Devices Free Cash Flow

Analog Devices has generated $3.2 billion in free cash flow over the last twelve months, translating to 32.8% 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 9.43%, 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 Q2 Results

With a market capitalization of $85.7 billion, more than $1.73 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

We were impressed by how strongly Analog Devices outperformed analysts’ earnings expectations this quarter. And we were also glad to see the improvement in operating margin. On the other hand, it was less good to see the inventory levels increase and gross margin deteriorated a little. Overall, we think this was still a really good quarter, that should leave shareholders feeling very positive. The company is up 3.01% on the results and currently trades at $168.9 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. We think Analog Devices is a good business. However, its revenue growth has been a little slower, and analysts expect growth rates to deteriorate from there. But on a positive note, its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion, and its impressive operating margins are indicative of an highly efficient business model.

Analog Devices's price to earnings ratio based on the next twelve months is 18.6x. There is definitely a lot of 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.

The Wall St analysts covering the company had a one year price target of $203.7 per share right before these results, implying that they saw upside in buying Analog Devices even in the short term.

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