Last week, chipmaker Analog Devices (NASDAQ: ADI) illustrated just how much market sentiment can dominate price action in the tech sector. On Wednesday, ADI reported third-quarter financials including a 17% drop in earnings, a 5% drop in revenue, and softer guidance for the current quarter. The stock price fell just 1.5% and quickly found support.
Two days later, when Donald Trump ‘ordered’ U.S. companies to cut ties with Chinese suppliers and customers, the stock fell over 4%, while the semiconductor sector fell nearly 5%. This was despite ADI already being under pressure on trade war concerns and a potential recession on the horizon. The share price is now down 17% from the record high less than a month ago.
Results Were Ahead of Revised Guidance
ADI’s management had already guided expectations lower, so the fact that revenue and EPS beat consensus wasn’t surprising. Third-quarter revenue fell 5% to $1.48 billion, $30 million ahead of analyst estimates. EPS declines 17% to $1.26, while analysts were looking for $1.22.
The decline in revenue came in the B2B segments, specifically the auto and industrial businesses. The auto business saw revenues decline 9% but only represents 15% of sales. The industrial business, which contributes 51% of revenue recorded a 4% drop in sales.
The Comm business increased revenues by 7% despite the ban on sales to Huawei. This is encouraging as the contribution to total revenue is 21% and growing. The consumer segment is relatively small but managed 18% sales growth.
Inventory turnover also fell slightly, which some analysts view as proof of a slowdown. The ban on shipments to Huawei resulted in an initial suspension of exports to that company, but deliveries resumed later.
The biggest takeaway from the results was softer guidance for the current quarter. Revenue is expected to be around $1.45 billion, which will show a year-on-year decline. However, full-year revenue is still likely to be slightly higher, despite a year-on-year decline in B2B revenue.
ADI Is a Solid Investment at the Right Price
Analog is very profitable, though margins have stopped increasing. There’s also a decent dividend yield of 2% with most of the free cash flow being paid out. Also, expenses are being managed well in the current environment.
ADI is very well positioned for the long term. In particular, the company highlighted the technology it is developing for electric vehicles and other applications for lithium-ion batteries. The company also produces products for the 5G, aerospace, and automation industries.
Challenges Are External
How well the company is valued depends on how sales go over the next year. That’s a tough call to make right now. ADI does appear slightly cheaper than its closest rival, Texas Instruments, which may reflect higher exposure to Huawei.
ADI finds itself in a similar position to Cisco. If there is a recession or if the trade war escalates, both companies will face challenges. For investors though, the bigger problem will be market sentiment as the entire sector will be under pressure. We saw last week how sensitive the semi stocks are to the news cycle.
If the trade war comes to a sudden end, then the current price of Analog Devices is probably a bargain – but that’s unlikely. ADI is, therefore, a risky prospect at the current level.
Friday’s close at $104.17 tested a critical technical support level. If that gives way, $95 is the next support level, followed by $87 and $80. These levels would all offer excellent buying opportunities if they coincided with a reversal in sentiment in the next few months.