Analysts are finally warning up to MACOM Technology Solutions Holdings Inc. (MTSI, Financial). Nordland Capital recently initiated coverage of the stock with a price target of $25, an upside of 37% over Tuesday’s price. Piper Jaffray also initiated coverage earlier this year with a neutral rating; their price target now reflects an upside of 22%.
Following the lead of the sell side, investors are taking a positive view of the company -- the stock is up around 14% since Monday's close. There seems to be no material catalyst for the price action over the last couple of days, though. The company only released a new transimpedance amplifier for supporting 12G-SDI transmission over optical fiber.
MACOM is trading around its 52-week low due to a slowdown in growth, acquisition costs and integration challenges related to newly acquired businesses like AppliedMicro and disappointing results for the first quarter of fiscal 2018.
The recent weakness in the stock, however, has created a buying opportunity as MACOM has exposure to the growth of cloud data centers and the upcoming spree of 5G spending in the telecom industry. At the current price, valuation also paints a favorable picture for the company.
Performance woes
MACOM Technology had a disastrous start to the year. The company missed top and bottom-line estimates for the first quarter of the year, falling short of the consensus revenue estimate by $2.3 million. The company aslo reported earnings per share of 10 cents, just shy of analysts' estimates of 13 cents. To top it off, the guidance for the second quarter was below the consensus mid-point revenue of $146 million and earnings per share between 10 cents and 16 cents. The guidance for full fiscal 2018 was affected as a result.
The graph above shows revenue estimates shifted significantly downward, as evident from declining full-year consensus. However, analysts are optimistic about recovery in earnings.
The graph above shows analysts are predicting a rising trend in earnings going forward. Nonetheless, the 2018 earnings consensus is down to 55 cents. It was previously more than $2 back in the second half of 2017.
What does this mean for investors?
In short, there is a buying opportunity as the market overreacted to the recent weakness in performance. Although the company struggled to post growth in the last quarter, it seems to be a transitional event as revenue growth is expected to recover in 2019.
Revenue is expected to reach around $700 million by year-end 2019, recovering the growth lost in 2018.
MACOM is exposed to the overall growth of the industry
The increase in revenue is possible due to MACOM’s presence in growth markets. The 100G-plus network port market is set to grow 34% between 2017 and 2020. Note that MACOM generates more than half of its revenue from networks.
Further, growth in the microwave transmission and mobile backhaul market is expected to resume in 2019, notes Dell’Oro Group. MACOM’s portfolio of products addresses the needs of these markets.
Moreover, the RF power semiconductor market is set to reach $31.26 billion by 2022, a compound annual growth rate of 15.4%; MACOM is among the key players in this market, alongside Broadcom Ltd. (AVGO, Financial), Infineon Technologies AG (IFNNY, Financial) and NXP Semiconductors (NXP, Financial).
Going forward, growth across the networking, mobile backhaul and RF markets will certainly help MACOM steer toward growth.
Valuation is favorable
Due to recent weakness in price, the stock is trading at a reasonable valuation. After accounting for the recent earnings consensus revisions, the stock is priced cheaply from a residual income perspective.
Assumptions for valuation
Earnings are expected to grow 15.5% per annum from 2019 to 2022; 1% earnings growth is assumed in perpetuity. Analyst consensus earnings are used for 2018 and 2019. Cost of equity is expected to grow in line with earnings growth. The capital asset pricing model was used to calculate the cost of equity.
Focus Equity Estimates
The valuation reveals an upside of around 40%, based on analysts’ consensus for 2018 and 2019. Although the consensus for 2018 seems warranted, estimates are quite conservative for 2019 despite the expected recovery. Nonetheless, the current price seems to be an opportunity to get in cheap.
Final thoughts
Fiscal 2018 is proving to be a hard year for MACOM as weakness in China and integration challenges related to recent acquisitions have hurt the stock. However, MACOM seems oversold as future growth prospects are still intact. Moreover, the overreaction from the market made MACOM a decent buy as valuation, adjusted for recent weakness, reveals upside.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
