Analog Devices: Is This Semiconductor Stock Undervalued After the Dip?
Analog Devices (NASDAQ:ADI) has been a major beneficiary of the rising demand for semiconductors. The company had a strong 2021 and has started 2022 with a good first quarter amidst strong demand from the industrial and automotive sectors. Its successful acquisition and integration of Maxim has further strengthened its analog semiconductor portfolio.
The share price also skyrocketed in 2021, but the stock has since entered a period of correction. Could the combination of a pullback and strong growth make this stock undervalued at current levels?
Strong market position
Analog Devices is one of the world's biggest analog chip manufacturers, specializing in analog signal processing chips. The company is continuing to benefit from more advanced and higher-priced semiconductor content in automobiles, 5G wireless networking equipment and industrial applications such as medical devices and factory automation equipment.
Analog Devices' organic sales are primarily comprised of data converters and amplifiers used in various end markets such as wireless base stations. The company has also expanded into power management chips through its acquisitions of Linear Tech and Maxim Integrated.
The automotive industry remains an especially promising end market for the company. Sensors, active safety systems and advanced infotainment systems all require semiconductors to function. Analog Devices also has a very strong market position in battery management systems for electric vehicles.
In industrial applications such as robots, factory equipment and medical devices, the company should see a similar trend of increasing chip consumption. The companys signal chain semiconductors are expected to play a significant role in 5G wireless network equipment.
Competitive advantages
Analog Devices main competitive advantages stem from its proprietary analog chip design and manufacturing expertise, as well as high switching costs. Because of its intangible asset base and switching costs, it is difficult to replace the companys analog chips once they have been designed into electronic devices.
Since analog chips make up a small percentage of a product's bill of materials, purchasing decisions are typically made based on performance rather than price, allowing Analog Devices to have strong pricing power. Customers in the automotive, industrial and communications infrastructure sectors, in particular, are unlikely to choose a subpar analog chip to save pennies on high-value equipment.
Due to its scale, Analog Devices is also maintaining its market leadership despite investing a lower percentage of its revenue in ongoing R&D and capital expenditures as compared to other digital chipmakers. It has a strong brand within an otherwise fragmented analog chip market, which makes it a preferred supplier and which is the reason for its strong market share lead. The company controls nearly half of the market for data converter analog chips, widely used in communications infrastructure equipment to convert analog voice signals to digital signals for processing and vice versa.
Collaboration with Gridspertise
Analog Devices recently announced a collaboration with Gridspertise, a new Enel Group subsidiary that provides cutting-edge sustainable solutions to distribution system operators to improve the resiliency and quality of smart grids worldwide. As more renewable energy sources come online, the collaboration will enable the development of contemporary hardware and software to support self-healing and adaptation of distribution grids.
The collaboration is based on Analog Devices and Enel's 15-year partnership on smart meters and grid digitalization resolutions. This time, Analog Devices has collaborated with Gridspertise to provide even more precise and accurate measurement and monitoring capabilities based on real-time data. This improves grid reliability by allowing utilities to improve operational efficiency and make a rapid transition to clean energy while also allowing flexible services.
The technologies can be used to improve legacy infrastructures from various geographies and life stages without the need for costly rebuilds. They also reduce the assets' environmental impact, making digitalization a key driver for more environmentally friendly power distribution grids. Furthermore, the Quantum Edge, Gridspertise's groundbreaking solution at the heart of the digitalization of secondary substations, benefits from Analog Devices power and precision technologies, which improve analog-to-digital conversion, precise measurement, metrology and isolation. This is the industry's first solution to fully virtualize the physical components of secondary substations, transforming them into customizable edge applications that enable new use cases and better grid management.
Final thoughts
With the markets falling due to rising inflation and interest rates, it could be a good time to fish for bargain opportunities, though we haven't really encountered a true selloff yet, so caution is still needed.
Like many of its semiconductor peers, Analog Devices stock has witnessed a general market correction in recent months. However, despite the correction, the company is trading at an enterprise-value-to-revenue multiple as high as 10.15 and a price-earnings ratio of 48.81. The stock is clearly commanding a massive premium for its strong market position, and this premium has not lowered much even in the correction. Despite a phenomenal business model and profit margins, I believe that Analog Devices is more of a watchlist candidate rather than a value opportunity at current levels.
This article first appeared on GuruFocus.
