NXP Semiconductors (NXPI, Financial) has just put in a full year of robust results so it may appear more savory to those concerned with past figures. Much improvement has occurred while I have been following and investing in the stock. However, it should be known that my concerns have consistently involved the firm's future with an emphasis on growing its reported earnings.
Actually, in many circles, there can tend to be an emphasis on cash flows, specifically free cash flow ("FCF"). On its Q4 Conference Call, NXP’s management has stated that it converted an astounding 20% of 2014 revenues into FCF and finished the quarter at a 29% margin. For reference, the corporation identifies FCF as operating income, or EBIT, minus capital expenditures ("CapEx"). CFO Peter Kelly says the company-wide focus this year -- including standard products, patent licensing, and manufacturing -- is to have a 26% EBIT margin. CapEx is guided to 5% of revenues. So, if management is on target, over a 20%, after investments in property, plant, and equipment, should be near investors' tables.
Total revenue for 2014 is recorded at greater than $5.6 billion. There is a domestic ramp up of secure credit cards in 2015 that is among NXP's catalysts. If forward revenues total only $6 billion, it would be reasonable to forecast $1.2 billion in FCF.
The only obvious hiccup might occur in Near Field Communications ("NFC"), which should now lie within the company's Secure Connected Devices business pursuant to reorganization. To help with any confusion pertaining to structural changes, here is a graphic from an October, 2014 company-produced spreadsheet:
Secure Connected Devices
Returning to NFC, NXP is the world's leading supplier of chips that are utilized for payment processing, banking, and other consumer uses. It has a broad base of customers who use its products, or integrated circuits ("ICs"), possibly to include China's ecommerce giant Alibaba (BABA) or a related firm(s). My own impression is that security is of paramount importance in payments. The backdrop includes incidents at Home Depot (HD) and Target Corporation (TGT) among others.
NXP's solutions are probably the safest, in part due to use of a Secure Element ("SE") to protect important information from hacking issues. However, CEO Rick Clemmer says:
…[some] carriers in the U.S. [have] really refused to let anyone other than (NXP customer) Apple (AAPL, Financial) implement a wallet with a secure element…the China opportunity will continue to be significant…
Further, devices running the Android operating system (GOOG, Financial) use a technology known as Host Card Emulation ("HCE") that does not require an SE. It is a possibility that Android devices will opt for other technologies -- through the intermediate term, at least.
NXP does have a new NFC product known as PN66T that combines a radio chip and an application loader, or "Smart element." It enables "Service providers to deliver a wide variety of secure element use cases with a single solution." The PN66T is clearly aimed at Android devices.
A recent report from Kantar Worldwide has the rival mobile operating systems each at very close to 48% of sales, with Apple's iOS pulling ahead. So, nearly half could be up for grabs. Potentially offsetting any Android loss would be growth in China -- which could also amount to another catalyst.
Secure Connected Devices also comprises microcontrollers ("MCUs"). Motion processing technology utilized by Apple's wildly popular iPhone 6 models falls within it. Some may recall Clemmer's colorful commentary a quarter ago: 'iFixit says in a tear down that it is an NXP microcontroller. I can't comment on that!'
Long term stability is not assured in handset MCUs. However, investors can turn to quarterly Conference Calls, stemming from the company's line of sight into new devices. Here is recent input from Vice President of Investor Relations, Jeff Palmer:
…we think can grow over a 3-year CAGR by 20% and that microcontroller business is one of the contributing factors of that kind of long-term growth.
Thus, there is probably no cause for concern until we hear otherwise.
Automotive
Vehicles are staying on the road for longer than they ever have in the past. Technology is a means for the industry to tap pent up consumer demand to buy new vehicles. NXP is clearly positioned to benefit.
Automotive connectivity is among the company's stronger future prospects. Its networking technology involves 802.11p specifications and supports terrific capabilities.
Ongoing business is seething. Consider this Conference Call excerpt involving keyless vehicle entry:
…with the exception of the Toyota in Japan and frankly a few models from Europe…the rest of the car manufacturing uses our technology associated with the remote keyless entry… original implementation was under $1 per key…[going] to several dollars to, in the most advanced cars, being double-digit dollars…[is] a significant opportunity for us.
With virtually all manufacturers turning to NXP for secure vehicle access, it may have pricing capabilities.
Secure Interfaces & Power
The new Secure Interfaces & Power division should be fine. A substantial portion of it is reliant upon a Chinese customer base for high performance radio frequency base stations ("HPRF"). No reason for worry is evident, in fact the company needed to invest in its backend fabs to keep up with overwhelming customer demand just prior to a semi-irrational October 2014 selloff. However, visibility into multinational end markets can be restricted.
Cybersecurity authentication might come up in some future headlines. There have been past discussions with Google about secure cloud access. Incidents at Sony Pictures (SNE) are merely the most recent to underscore the need for solutions.
Capital Allocation
First Quarter 2015 revenue guidance of $1.47 billion is close to the previous consensus. A 25% forecast operating margin, while healthy, remains beneath the 26% threshold specified two quarters ago for diverting funds to Research & Development ("R&D"). If Alibaba is indeed an NFC customer, any effect upon margins should be observed.
Discussion of R&D expenditure does not tend to be focal. It would make sense that the company has a small number of star engineerswho it should attempt to keep. Of course there are other considerations in addition to human capital.
Though in favor of the corporation's aggressive buyback, its recent dilutive offering is a bit questionable. Pursuant to substantially lowering its share count since June, 2013, NXP has suddenly issued convertible debt, paying 1% per year for the opportunity to issue nearly 11.2 million shares, at $102.84, in 2019. Yet the company bought back 2.4 million in Q4.
In the event a dividend is declared, fiscal responsibility should ultimately be lower: there would be fewer shares.
For the foreseeable future, all of its prodigious FCF is going toward additional repurchases. It seems to be a matter of months before the diluted share count is reported to be under 240 million, despite conservative guidance.
Valuation
Different peers are selected for price to earnings comparisons. The grouping I have been using includes firms with automotive operations such as Freescale (FSL, Financial); a somewhat commoditized, but compellingly valued chipmaker that has made some balky acquisitions in ON Semiconductor Corporation (ONNN, Financial); Broadcom (BRCM) a $26 billion company that offers NFC; and Texas Instruments (TXN, Financial), probably the biggest analog chip maker by market cap. Two other Apple suppliers that have also really outperformed the market in Avago Technologies Limited (AVGO, Financial), with extensive Chinese business; and Skyworks Solutions (SWKS, Financial), with its own recent automotive design win; are included.
Here is data in table format when using 2015 bottom line earnings estimates (2016 being too far off for comfort).
NXP, Avago, and ON trade at a lower forward PE multiple than the average and have a higher forecast long term growth rate per consensus estimates. I think NXP can probably get to 15x -- or $85.50. As a remarkably healthy business with long term viability, a higher share price is easily justifiable here.
When using $1.3 billion in 2015 FCF, based on a 21% margin, and a share count of 243 million ( 242 million diluted currently - 2.5 million shares repurchased per quarter + 11.2 million in convertible debt ) the result is $5.35 per share. Applying a 16x multiple, the target price is $85.60 ($89.66 without the convertible debt). Thus, estimates further into the future are needed to use FCF in support of substantial share appreciation.
Either way, substantial downside is not evident.
The stock has consistently rewarded anyone who has bought into dips. There is lacking indication that it has changed. However, while metrics show upside, the trajectory might be slower, particularly in comparison to NXPI's lower P / E multiples in 2013 - 2014.
Conclusion
As shown in Q4 2014 results, NXP semiconductors has several lines of verdure business. Future potential is beyond question. While such a healthy corporation is a sensible option for investors with a long term mind set, something new might be needed for valuation to really set it apart in the near term.
Once we are closer to 2016, some metrics could be more compelling.
Anyone getting acquainted might find an opportunity if Android NFC share is lost before any Alibaba announcement. Of course, questions could be addressed in the reverse order.
