Skyworks Solutions Inc. (SWKS, Financial) is up an impressive 87% since my recommendation last September. The stock held strong even during the market selloff earlier this year as investors continued to appreciate the company's debt-free business model that enables it to step strongly into the future.
The expected launch of 5G technology, on the other hand, played a massive role in the successful market performance so far. The question asked by many investors is whether to book the handsome profits or to hold on to the stock in anticipation of more capital gains. A careful analysis of the market opportunity and Skyworks’ fundamentals suggests the latter is the right decision.
Identifiable catalysts
The performance of the stock has not only been driven by expectations, but also real numbers. The company beat earnings estimates for the fiscal third quarter, which ended June 30, handsomely (earnings per share of $1.25 versus expectations for $1.13) and guided for higher-than-expected earnings for the quarter ending Sept. 30 as well. There are a few catalysts that could drive earnings higher in the coming years, which would be duly followed by an increase in the market value of the company.
The rollout of 5G technology has yet to happen in many countries. The stock price, so far, has reacted positively to this news and it’s likely to remain the same for multiple years as consumers trigger a super cycle of device upgrades to grab a piece of the latest technology. Speaking at the Morgan Stanley European Media & Telecom Conference in November last year, AT&T Senior Vice President of wireless technology Igal Elbaz said:
“We really believe we are going to see a big refreshment of devices starting next year. I think people are excited and may be holding to see when the 5G devices are going to come with those new capabilities, and we are pretty confident this is what we are going to see in the marketplace.To ensure smartphone sales pick up again, mobile providers are starting to emphasize 5G performance features, like faster speeds, improved network availability, and enhanced security. As soon as providers better align their early performance claims for 5G with concrete plans, we expect to see 5G smartphones account for more than half of phone sales in 2023.”
Skyworks CEO Liam Griffin reaffirmed this outlook during the most recent earnings conference call on July 23. He went on to discuss the company’s strong position in multiple industries:
“With 5G gaining traction, we are now at the cusp of a multiyear upgrade cycle, one in which Skyworks is uniquely positioned to outperform. Our Sky5 platform provides tremendous flexibility to our customers, purpose-built to be baseband agnostic, while powering the most innovative 5G handsets. In addition, these same 5G solutions are now expanding across industrial and automotive applications. And as complexity intensifies, we are aggressively adding to our enabling technologies, with ongoing investments in both TC-SAW and Bulk Acoustic Wave filtering. In fact, we just exceeded shipments of 150 million BAW-enabled modules and we see strong momentum for this technology in both mobile and broad markets. Our proven ability to advance key connectivity protocols, delivering higher speeds and lower latency, across 3G, 4G, and now 5G, positions us well to capitalize on rapidly evolving market opportunities. Indeed our mission of connecting everyone and everything all the time has never been more relevant.”
Skyworks’ partnership with Apple Inc. (AAPL, Financial) is one of its greatest strengths, and the expected launch of the 5G-enabled iPhone is likely to drive the demand for mobile chips higher for at least a couple of years. Warren Buffett (Trades, Portfolio) is not ready to underestimate the power of the iPhone just yet, and investors should follow suit. For the quarter ended June 30, Apple reported iPhone sales of $26.4 billion, easily beating the estimate of $22.2 billion set by Wall Street analysts who expected the company to take a massive hit from the current economic recession. The resilience of Apple is good news for Skyworks as an uptick in iPhone sales will lead to a bump in demand for the chips used in these devices.
The unique debt-free position of the company could be a driver of value as well. The spectacular decline of business giants such as Hertz Global Holdings Inc. (HTZ) has refreshed memories about the risks of investing in debt-ridden companies. This will trigger investors to attach a premium to companies with manageable amounts of debt, and Skyworks will stand out as the company is continuing to grow without the need to raise capital.
Skyworks is not cheap
It would have been a bargain had Skyworks traded at cheap valuation multiples. In line with many growth companies that are outperforming the earnings growth rate of the broad market, Skyworks is trading at lofty earnings multiples. The table below provides an accurate description of the company; a financially strong, highly profitable stock that is priced to grow exponentially.
Source: GuruFocus
The increase in demand for smartphone chips resulting from the launch of 5G devices, however, will prove to be a catalyst that will drive industry earnings for multiple years, which would be a good enough reason for Skyworks to trade at high multiples. Value investors, however, might not want to open a new position, but for growth investors, the risk-reward profile still looks attractive considering the projections for the exponential growth of the industry.
The greatest strength is its biggest weakness
As noted earlier, Apple is Skyworks’ largest customer. According to data from company filings, the smartphone manufacturer accounted for 51% of the company’s revenue in fiscal 2019, up from 47% in 2018. There is no immediate threat for Skyworks, but generating more than half of its revenue from a single customer is not a welcome sign for investors. In the unfortunate event of a termination of the business relationship between the two parties, Skyworks would find it difficult to meet revenue and earnings guidance until new clients are onboarded, which could take months if not years.
To add salt to the wound, Apple is a company known for exerting pressure on suppliers to meet delivery deadlines even under apocalyptic market conditions. The technology giant has received backlash for requesting suppliers to amend the terms in business contracts to tilt the odds in favor of Apple as well. In June, the tech giant announced its decision to manufacture its own chips for Mac computers starting in 2021, ditching its partnership with Intel Corp. (INTC, Financial). For now, Skyworks seems to be safe from such a catastrophic event, but investors need to seek a higher premium to account for the possibility of this risk materializing within the investment time horizon.
Takeaway
The positive outlook for the semiconductor industry, the company's balance sheet strength and the competent management team make Skyworks a very attractive investment. The only concern for an investor should come from its rich valuation multiples, but growth investors should still find the company investable considering the massive leeway for growth available in the coming years. Risk-averse investors, however, might find Skyworks a difficult company to invest in at the current level of valuation.
Disclosure: I own shares of Skyworks Solutions.
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