Though InvenSense (INVN, Financial) is a fundamentally solid company and has an established presence in the sensor solutions industry yet the performance of the stock in the last twelve months is clearly a big disappointment. However, certain analysts are citing this as a short-term weakness and in the long-term, it is expected that the company will build on the burgeoning demand for smartphones, tablets and other smart devices. Besides these, InvenSense’s products are also widely used in the automotive sector as well. Therefore, let us analyse is the stock is a strong long-term buy and whether the current lows provide a lucrative point.
Highlights
In the second quarter, InvenSense failed to meet Street expectations and the shares went for a slide thereafter. Fiscal second-quarter revenue came in at $90.2 million, near the high end of the management guidance given at the end of first-quarter. This did, however, miss analyst consensus of $90.48 million. While this was a narrow miss, the company widely missed the estimate on earnings with an EPS of $0.05 per share as compared to the $0.16 per share that the Street was expecting. This massive decline was caused by shift in customer mix. Basically, a reasonable chunk of InvenSense’s business was attributed to smartphone vendors Apple and Samsung in the second quarter. As per the management, sale to these companies carries lower margins as compared to other customers. Accordingly, the margins took a hard hit in the quarter.
However, the trouble with this concern is that it is sustainable and as the company even highlighted, Apple (AAPL, Financial) and Samsung (SSNLF, Financial) dominate its sales mix and therefore, it is highly plausible that we could see weak margins in oncoming quarter as well. Perhaps, this is the reason that the management has guided its earnings range at $0.17- 0.21 per share for the third quarter that is hugely below the analyst estimate of $0.30 per share. On December 3, Forbes reported that InvenSense had entered the oversold territory as the company hit a RSI reading of below 30. Sure, this is a pretty straightforward sign that the stock is prone to heavy volatility but as the article itself points out, this could very well be a buying opportunity.
The trouble is here to stay for a while
Now, for a stock to be considered as a viable buying opportunity, it should have strong fundamentals. In my opinion, InvenSense is a robust company when looked from an innovation and product development front. However, the pressure on margins because of a skewed sales mix has cost the company dearly. Now, the situation is that this problem of lower margins is the one that can be expected to stay. Since Apple and Samsung are InvenSense’s biggest clients, it is next to impossible that the company would like to loose them in the future. Both of these big players especially Apple has a tendency to put pricing pressure on its suppliers to get the best ASPs and therefore, in the future as well, this will persist.
The fix to this problem, one that even the company is trying to adopt as well is increasing revenue in the high end of its guidance of 25 to 35 percent. The benefit from this proposition would be that a strong and consistent topline growth will translate gradually into strong bottom line growth. Also, addition of newer customers like LG and Xiaomi and launch of wearable products represent a huge opportunity for InvenSense. Thus, investors with a longer horizon can expect that the company will be able to return to expected margins of 50 to 55 percent. The reason I called out investors with longer horizon is because this comeback would take time as the company will try to make changes in its product and sales mix.
Thoughts on the Broadcom rumor
Just recently, rumors have surfaced that Broadcom (BRCM, Financial) might be looking at InvenSense as a potential acquisition candidate. Though these are still unconfirmed rumors yet let us briefly explore the consequences of any such activity. First off, it is highly important for investors to understand that even though Broadcom and InvenSense serve the same end market, their product portfolios are vastly different and therefore, the possibility of production leverage is minimal.
However, considering the fact that there is consolidation happening in the diverse smart devices market, Broadcom could actually find synergies in the acquisition of InvenSense. Broadcom may look at InvenSense for its future in the emerging and diverse wearables market in order to help maintain their own pricing power. Also, since the customer domain is similar for both of these enterprises, there is undeniable synergy that can come from this combination. As for the price that can be offered by Broadcom for InvenSense’s share, I would refrain from speculating at this juncture. Since, this is a mere rumor at this stage, it would not be wise to put a price tag on the transaction as it could prove to be misleading.
Final words
Barring the weakness in margins that InvenSense is currently facing, the company is fundamentally strong mainly because of its strong product portfolio. The company has shown confidence in achieving a sturdy revenue growth in the future and that is a big positive for investors. Needless to say that at this price level, InvenSense does provide a favourable entry point for long-term investors, seeking value.
