One of the industries that really helped push the S&P 500 into a correction this month was Semiconductors. On October 9, Microchip Technology (MCHP) warned and their CEO, Steve Sanghi, essentially 'called the top' in the Semi cycle. Here's what he said...
'We believe that another industry correction has begun and that this correction will be seen more broadly across the industry in the near future.'
This caused the SOX, the Philadelphia Semiconductor Index, to drop 8.8% in two days, especially after a Goldman Sachs chip analyst issued a report agreeing with Sanghi.
But a curious thing happened as the S&P 500 began its own deeper correction last week, falling over 4% in 3 days: the SOX stopped going down and didn't go any lower while the big cap index was dropping.
And this made more confident about my purchase of Avago Technologies (AVGO) when it was on sale in the $70s again, especially as other Semi analysts chimed in that Microchip's woes and insight were unique. And it doesn't hurt that Avago is making great, in-demand technology for Apple (AAPL) right now either.
Elite Pedigree and Customers
Avago, a Singapore incorporated company with joint headquarters in San Jose, California, is a leading designer, developer, and supplier of a broad range of analog semiconductor devices and digital, mixed signal, and optoelectronics components and subsystems. These innovations are used in wide range of wireless, wireline, and industrial applications.
The company started as a Hewlett Packard (HPQ) semiconductor division in the 1960's and was later a part of Agilent that was spun-off from HP with an IPO in 2009. The $18 billion company makes radio frequency chips that are used in smartphones by Apple, Samsung and other mobile device manufacturers.
Avago products primarily serve four markets: Enterprise Storage (38% of FY 2013 revenue), Wireless Communications (25%), Wired Infrastructure (23%), and Industrial & Other (14%). It has a diversified revenue model with 37% of its FY 2013 revenue derived from China, 20% from North America, 10% from Europe and 33% from the rest of the world.
On May 6, Avago closed the acquisition of LSI Corporation. Subsequent to the acquisition Avago joined the S&P 500 index, replacing LSI Logic.
Oppenheimer analysts estimate that Apple represents about 15% of Avago sales, and that the company saw a doubling of content in iPhone 6/6+ vs iPhone 5s/5c by securing the ultra-high- and high-band LTE PADs. Clearly, the super strong iPhone 6 sales reported on Monday helped drive AVGO shares up 6% the next day.
'Top of the Cycle' Are Fighting Words
Here's what Stern, Agee analysts had to say after the MCHP-GS 'top call' in the Semi cycle...
We believe the Microchip commentary was to a broader weakness in China and inventory correction concerns. We believe the best space should be 'product cycle' names and the pullback is an opportunity. We are buyers on AVGO, Skyworks Solutions (SWKS), and NXP Semiconductors here as strong product cycles with EMV, Automotive, and upcoming multiple iPhone-iPad launches position the names very attractively into 1H15. For AVGO, we see another strong 2015 wireless and datacenter into China. Also, these 3 names are trading at 11-13x with significant product cycles and earnings visibility presenting attractive opportunities. While a broader macro weakness will be an overhang in the vanilla names with no specific product cycles - we believe the sell-off is an opportunity to build positions in some of the leaders in Semis with solid execution and product cycles.Vertical EPS Revisions
In the past 60 days, earnings estimates for Avago for this year have gone from $3.31 to $4.12, a 24.5% increase. And 2015 projections have vaulted from $4.59 to $5.86, a 27.7% jump. These numbers represent 58% earnings growth for this year and 42% for next year. Here's a look at the potential 'earnings path' based on analyst estimates...
You can also see that these are the kind of implied growth rates that make growth stock portfolio managers salivate. What this graph doesn't show you is where those consensus EPS estimates were before the most recent company guidance in August. In May, 2014 estimates were raised from $3.01 to $3.31 (+10%) and 2015 estimates were hiked a whopping 31% from $3.50 to $4.59. That was already a powerful bump in the company's earnings momentum and outlook.
Analysts and Funds Target Higher Prices
After AVGO's second-quarter earnings report in May, and the subsequent estimate bumps, I took a look at this Zacks #1 Rank to see if it had something else that makes it a buy for me: strong institutional interest. I found that the $275 billion Capital Research Investors disclosed a big position of 25.8 million shares (10% of the company) in early May in a 13G filing.
This was likely in reaction to the company being added to the S&P 500 after they closed their acquisition of LSI. But knowing some of the holdings and strategies of Capital Research, a sister fund of the equally large Capital World Investors, this is a growth play for them as well.
All these facts made me a buyer of AVGO in mid-July in the low $70s. We didn't have to wait long to sell in the high $80s on the price surge into early September, for a gain of over 20%. So you can imagine why I couldn't resist the chance to buy the shares on sale again in the low $70's last week.
Finally, here's where most of Wall Street stands on AVGO shares, with recent dates when they raised their outlook and/or their price targets (PT)...
OCT 16 Brean Capital: Upgrade to Buy, PT $87.00 OCT 06 Canaccord Genuity: Buy, Boost PT to $97.00 SEP 30 Nomura: Buy, Boost PT to $95.00 SEP 09 Barclays: Overweight, Boost PT to $100.00 SEP 05 Citigroup: Buy, Boost PT to $100.00 SEP 02 DA Davidson: Neutral, Boost PT to $84.00 AUG 29 RBC Capital: Buy, Boost PT to $99.00 AUG 29 Jefferies Group: Buy, Boost PT to $84.00 AUG 29 Barclays: Buy, Boost PT $90.00 AUG 29 Morgan Stanley: Positive, Boost PT to $97.00 AUG 29 Pacific Crest: Outperform, Boost PT $90.00 AUG 29 Oppenheimer: Outperform, Boost PT $100.00 AUG 29 Deutsche Bank: Buy, Boost PT $90.00
Bottom line: In a 'semi-strong' Semi industry, this is one large cap name I want to own for growth with solid business footholds in both enterprise networking and mobile devices. They would seem to benefit from all dimensions of a more connected world.
Disclosure: I own AVGO shares for the Zacks FTM Portfolio.
