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Why is Avago Technologies an Ideal Investment Candidate?

August 25, 2014 | About:
Riddhi Kharkia

Riddhi Kharkia

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Avago Technologies (AVGO) is on a roll in 2014, having gained around 32% on the stock exchange so far. The chipmaker's business is being accelerated by smartphone giants including Apple (AAPL) and Samsung (SSNLF), to whom it supplies radio frequency chips. In fact, according to UBS Investment Research, Apple and Samsung are expected to account for 60%-65% of Avago's revenue in the current fiscal.

Samsung's latest flagship smartphone has been selling at a reasonable pace (even though the sales haven’t been terribly impressive) and there is already positive chatter around Apple's iPhone refresh. As such, Avago's prospects look strong. Moreover, growth in the Chinese LTE handset market adds to the company's smartphone opportunity. In short, Avago's performance should continue improving due to two simple reasons – Apple and Samsung.

Apple to strike again

Avago is expected to derive a big chunk of its revenue from the two smartphone titans. In the previous fiscal year, it generated around 20% of its revenue from Apple contractor Foxconn. Avago is a key Apple supplier, as its RF chips can be found in both the iPhone and the iPad. The last two iPhone generations have Avago chips in them, and it also scored a deal with the iPhone 5s.

The company looks set to land the lucrative Apple spot in the rumoured iPhone 6 as well. In the previous conference call, Avago CEO Hock Tan said the company expects "the beginning of a ramp from our North American smartphone customer as they transition to their next-generation platform."

Beyond doubt, it can be concluded that Avago is talking about Apple, which is expected to bring out a revolutionary smartphone this time. As reported on AppleInsider, Apple is expected to launch the next iPhone in late September, so it must have started the production ramp by now. Cupertino is expected to upgrade the iPhone's screen to 4.7 inches this time. Additionally, a 5.5-inch phablet also seems to be in the cards.

If Apple is one pillar, Samsung is the other.

On the other hand, Samsung itself is delivering solid smartphone growth. Sales of the Galaxy S5 were better than its predecessor in the first month by 10%. The device has helped Samsung capture the No. 1 spot in the U.S. smartphone market. Avago had supplied three chips for the Galaxy S5, including power amplifier modules and FBAR filters.

Additionally, Samsung is one of the leading smartphone sellers in China (recently overtaken by Xiaomi as per a survey), where LTE phones are gaining momentum. According to Goldman Sachs, 142 million LTE smartphones are expected to be sold in China this year, followed by 235 million units next year. Avago management is counting on this opportunity to power up its smartphone sales. It supplies chips to the leading smartphone player in China, Samsung and this will allow it to make the most of this market.

The rumours making the rounds of the media suggest that Samsung may actually come out with the next generation of its flagship device Galaxy S. The new device Galaxy S6 may be pitted directly against iPhone 6 and will compensate for the weak sales delivered by the S5 model. Additionally, it is stipulated that, besides announcing the release of Galaxy Note 4 in the month of September, it will actually be launched in the same month. Thus, Avago investors have a lot to rejoice about as it is a primary supplier for Samsung’s smart devices

Takeaway

Avago is slated to benefit from three major catalysts in the smartphone market – Apple, Samsung and China. Additionally, the company also pays a dividend yielding 1.60% and is currently trading at a forward multiple of around 14.58 as compared to an industry average of 15.61. As such, Avago is a worthwhile investment candidate for your portfolio.

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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