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Is Skyworks Solutions a Buy?

Matthew Cochrane, The Motley Fool

Few stocks offer as much promise and risk as Skyworks Solutions (NASDAQ: SWKS), the producer of innovative analog semiconductors and RF solutions that enable the wireless connectivity that many of today's most popular mobile devices need to function. The company is fraught with geopolitical and international security risks caused by rising tensions between the U.S. and China, as it supplies some of the companies most impacted by the tariffs. It is also on the cusp of being one of the companies to benefit most from the coming 5G wireless revolution.

Skyworks Solutions' stock price has already taken investors on a wild ride this year. From the turn of the year to mid-April, its shares have rocketed up 40%, only to give up almost all of those gains in the weeks since. Let's take a closer look at what has caused this extreme volatility and at the company itself to see if it makes for a good investment today.

A city's night skyline with 5G in the top right corner.

Skyworks Solutions believes it will sell 40% more content for 5G-capable smartphones than it does in 4G sets. Image source: Getty Images.

Crunching the numbers

In Skyworks Solutions' second quarter, revenue dropped to $810 million, an 11.3% decrease year over year, and non-GAAP earnings per share (EPS) shrunk to $1.47, a 10.4% decrease year over year. The company's adjusted gross margin held steady at 50.7%, but the adjusted operating margins contracted to 34.1%, a dip of 2.2 percentage points from last year's second quarter. The guidance for next quarter was not much better, with management again projecting year-over-year declines in both revenue and earnings. The weakness in the top and bottom lines, management said, was driven by soft mobile sales, particularly in China, where Skyworks supplies many of the major smartphone manufacturers.

The company did repurchase almost $80 million of shares in the quarter and, at its current price, supports a dividend yield of about 2.15%.

Based on the company's trailing 12 months of EPS, shares are currently trading at a P/E ratio of about 10.2, meaning that a lot of bad news is already baked into the company's cake. Let's try to determine if this is justified.

Why Skyworks is grounded

There are three primary factors hurting Skyworks right now:

  1. The current state of the smartphone market. Many analysts now believe we are at "peak smartphone," meaning that the market has largely matured, with most global consumers who want one and can afford one now owning one. The market is also inherently lumpy, with major product launches spread out over several years.
  2. Skyworks is a casualty in the trade war between the U.S. and China. Many of Skyworks' largest customers are directly impacted by the tariffs, including Apple, which accounted for more than 40% of Skyworks' sales in its 2018 fiscal year.
  3. Finally, earlier this month, President Trump issued an executive order that seemingly banned Huawei equipment from supplying U.S. networks due to cybersecurity concerns. Huawei is a major customer of Skyworks, and the news drove Skyworks' stock price down hard this month. Oddly enough, though, the situation is not completely unprecedented. In April 2018, the U.S. Commerce Department announced a seven-year ban on U.S. companies selling to ZTE, a Chinese smartphone maker, for violating sanctions in place against Iran and North Korea. Skyworks' stock price plunged almost 15% that month but, as ZTE entered negotiations to make a deal with the U.S. government, Skyworks' shares began to recover and had made up the losses by early summer.  

Skyworks' opportunities

Against the backdrop of these problems, Skyworks is fast approaching an opportunity that could cause its revenue and earnings to escalate exponentially. For smartphones capable of 5G wireless speeds, it will provide far more switches, bands, and filters than it does for phones only capable of 4G speeds. This will increase the average dollar content of Skyworks materials in each smartphone from $18 to $25, a 40% increase!

The inside of a 5G smartphone showing different Skyworks components.

Skyworks Solutions content will dramatically increase in smartphones that are capable of 5G speeds. Image source: Skyworks Solutions.

The launch of 5G will also introduce more and more connected devices into the Internet of Things (IoT), giving Skyworks a larger base of devices to sell its RF solutions into, a front where it is already winning a number of designs wins. In the company's second-quarter conference call, CEO Liam Griffin read through a number of its recent design wins and concluded:

Skyworks is capitalizing on powerful macro trends, diversifying across new customers and segments while advancing our market leadership. Our solutions empower everything from data center to cloud, media to entertainment to e-commerce and ride-hailing services. Moving forward, the transformational technology of tomorrow is being built on a new generation of connectivity solutions, enabled by the rollout of 5G. The applications driving this revolutionary change require a step-function leap in performance, supporting the continuous interaction between client and cloud while delivering high-speed data, near zero latency and perfect reliability. Skyworks' unique systems expertise, strategic partnerships and global scale are critical to the success of 5G deployments.

Weighing the risk and reward

For shareholders, the ride will almost certainly continue to be volatile, though I believe ultimately rewarding. While it is impossible to accurately forecast world politics, the U.S. and China both stand to lose a lot if a deal is not eventually reached, something that would potentially open up Huawei's business for Skyworks once again. Even if a deal is not reached, Skyworks valuation is so cheap that the permanent loss of this business is seemingly already priced in. While trade negotiations could last much longer, and make many more unexpected twists and turns, the regulations targeting Huawei are unlikely to be permanent.

While the outcome of the trade war is uncertain, the arrival of 5G in the coming years is not. The standards have already been approved by government agencies around the world and major telecom carriers and device makers are already working on the release of these products to consumers. Skyworks has already secured the designs for many of these products, meaning that it is highly unlikely for another company, with less expertise in the space, to displace it.

Long-term investors can take advantage of this weakness -- and future volatility -- by continuing to add Skyworks at attractive valuations, skewing the odds in their favor to end up with a market-beating investment. That's what I've done in my own portfolio, and I continue to believe that patiently waiting for the 5G thesis to fully play out will ultimately prove to be rewarding.

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Matthew Cochrane owns shares of Skyworks Solutions. The Motley Fool owns shares of and recommends Apple and Skyworks Solutions. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.