Manufacturer of analog chips, Analog Devices (NASDAQ:ADI) reported Q4 FY2021 results topping analyst expectations, with revenue up 53.2% year on year to $2.33 billion. Guidance for next quarter's revenue was $2.6 billion at the midpoint, 5.08% above the average of analyst estimates. Analog Devices made a GAAP profit of $75.6 million, down on its profit of $386.5 million, in the same quarter last year.
Analog Devices (ADI) Q4 FY2021 Highlights:
- Revenue: $2.33 billion vs analyst estimates of $2.3 billion (1.33% beat)
- EPS (non-GAAP): $1.73 vs analyst estimates of $1.70 (1.9% beat)
- Revenue guidance for Q1 2022 is $2.6 billion at the midpoint, above analyst estimates of $2.47 billion
- Free cash flow of $809.9 million, up 48.9% from previous quarter
- Inventory Days Outstanding: 90, down from 111 previous quarter
- Gross Margin (GAAP): 47.9%, down from 67% 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 slow, averaging 6.64% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $1.52 billion to $2.33 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 fantastic quarter for Analog Devices with 53.2% revenue growth, beating analyst estimates. This marks 5 straight quarters of revenue growth, implying we are mid-cycle for Analog Devices, as a typical upcycle tends to last 8-10 quarters.
Analog Devices believes the growth is set to accelerate, and is guiding for revenue to grow 70.3% YoY next quarter, and Wall St analysts are estimating growth 43% 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 90, 20 days below the five year average, showing no indication of an excessive inventory buildup at the moment.
Analog Devices's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 47.9% in Q4, down 19.1 percentage points year on year as the company completed the acquisition of Maxim Integrated.
Gross margins have been trending down over the last year, averaging 63.2%. However, Analog Devices's gross margins remain one of the highest in the semiconductor group, driven by strong pricing power from its differentiated chips.
Analog Devices reported an operating margin of 43.1% in Q4, up 1.4 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 down over the last year, averaging 39.4%. However, Analog Devices's margins remain one of the highest in the industry, driven by its strong gross margins and economies of scale generated from its highly efficient operating model.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 13% 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 $809.9 million in Q4, up 26% year on year.
Analog Devices has generated $2.39 billion in free cash flow over the last twelve months, translating to 32.3% 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 Q4 Results
With a market capitalization of $99.6 billion, more than $1.97 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 the exceptional revenue growth Analog Devices delivered this quarter. And we were also glad to see the inventory levels go down. On the other hand, it was less good to see the pretty significant deterioration in gross margin. Overall, we think this was a strong quarter, that should leave shareholders feeling very positive. The company is flat on the results and currently trades at $185.44 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. Its revenue growth has been very weak, but at least that growth rate is expected to increase in the short term. 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 25.6x. 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 $194 per share right before these results, implying that they saw upside in buying Analog Devices even in the short term.
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