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Why is Avago Technologies a Valuable Buy?

July 01, 2014 | About:
Riddhi Kharkia

Riddhi Kharkia

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Avago Technologies (AVGO) looked like a promising investment at the end of last year, and the company has delivered on it so far in 2014. Since the beginning of 2014, the stock has surged nearly 38% on the back of growing smartphone markets. But this stellar performance has made Avago shares expensive at 29 times trailing earnings, while the dividend yield has come down to 1.70%.

Moreover, the stock is trading close to its 52-week high, and Avago investors might be wondering if the stock is worth holding on to anymore. Well, the answer is that it is. Avago’s key clients Apple (AAPL) and Samsung (SSNLF) are going to take the smartphone war to the next level this year. Since Avago plays from both sides, there's a high probability that it will see solid revenue and earnings growth this fiscal year as well.

Smarter phones for smart people

Since Avago's wireless communications business accounts for half of its top line, the boost that it is supposed to receive from Apple and Samsung will play a big role in its financial performance. In fact, in the previous quarter, despite subdued production of Apple's iPhones, Avago managed to increase its wireless revenue, year over year. This was down to "sustained demand from a large OEM customer," which could be Samsung as it is ramping up production and sale of the Galaxy S5.

Apple is expected to come into play later this year when it launches bigger iPhones. With the rumors around the launch of iPhone 6 gaining strength with every passing day, it is expected that the next iPhone product from Apple will include revolutionary features and break company’s previous sales records. Apple was a 10%-plus customer of Avago last fiscal year as the company gained content in the iPhone.

Now, we could be looking at a bump in the addressable market for Apple this year as it introduces bigger-sized iPhones. Additionally, Avago also supplies content for iPads and hence, it could see more Apple goodness later this year with the new iPad cycle.

Beyond Apple and Samsung

It is never a good idea to keep your eggs in one basket, so Avago decided to diversify and land a few design wins in China. The deployment of TD-LTE in China has created demand for LTE-enabled smartphones, and Avago management says that the company has won meaningful content in Chinese smartphones for the first time.

This is a significant opportunity for Avago, since 4G smartphone shipments in China are expected to rise to 72.6 million this year from 4.6 million units last year. By 2017, iSuppli expects that there will be 300 million 4G handsets in the Middle Kingdom. So, Avago has made a smart move by moving into this market.

Besides, Avago is enjoying solid growth in its wired infrastructure business, which was up almost 60% in the last quarter. The long-term outlook for this business looks bright, since Cisco is another 10%-plus customer of Avago. The proliferation of connectivity around the globe with different applications in the Internet of Things and the Industrial Internet will lead to demand for data-center equipment and faster connectivity equipment going forward.

Avago is looking to make full use of this opportunity through its product development moves. It recently launched its latest solutions -- MicroPOD and MiniPOD -- in association with Corning that enable data centers and enterprise networks to switch from 10G to 100G Ethernet.

Takeaway

Avago has appreciated strongly this year and the stock isn't as cheap as it was in December last year. However, it is still cheap -- at less than 30 times earnings -- when compared to the industry average P/E of 43.As such, it is still a good idea to hold this stock, especially considering the catalysts that it has in store.

About the author:

Riddhi Kharkia
A practicing Chartered Accountant based out of India. I have keen interest in analyzing tech stocks that are driven by value.

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