Semtech Hitting Its Stride

We maintain our Buy rating on the shares of Semtech Corporation (SMTC), a fabless supplier of analog and mixed signal semiconductor devices. July quarter revenue was in-line with consensus estimates, while the EPS exceeded.

Shares of Semtech are currently trading at a 15.6x multiple of price to our current 2009 earnings estimate (P/E). The healthy pipeline and robust design win activity are encouraging. The backlog increased again in the last quarter, with lead times stretching out a bit. The margin story surrounding the stock is regarding its power management product line. The new power management products will raise the segment gross margin to within the long-term targeted range.

Therefore, cash flow is likely to strengthen. While the Reynosa fire will result in weaker results for the power discrete product line, the net impact on overall results is not expected to be too great. Although the macro situation in the U.S. was expected to impact consumer spending, the consumer segment grew very strongly in the last quarter, and management expects continued growth in Q3. We expect the shares to trade higher within the next six months.

Consequently, we are reiterating our $20 price target (21.1x P/E) and recommending investors to accumulate shares. The TTM ROE (based on pro forma profits) has grown in each of the last five quarters, and was 17.2% in the last quarter. The DuPont analysis clearly indicates that all the three basic components of the ROE have grown during this period. New higher-margin power management products and increased production overall are gradually improving profitability of the business.

Opnext Fairly Valued Around $7

Opnext, Inc. (OPXT) reported revenues of $84.2 million in Q1:FY09, up 24.2% year-over-year and up 15.8% quarter-over-quarter. Gross margin of 32.2% was down from 32.9% in Q4:FY08 and 35.0% in Q1:FY08. Proforma EPS came in at $0.06, exceeding our estimate by $0.02. Cisco (CSCO) and Alcatel-Lucent (ALU) accounted for 44.3% and 10.2% of the total sales, respectively, in the quarter.

On the call, management stated that it plans to expand its 40G capacity by 20% by the end of the fiscal second quarter and by 50% by the end of CY09. Foreign currency exposure (80% COGS, 50% Opex) again provided a drag, contributing to a negative 210 bp impact during the quarter. Going forward, the company expects to generate revenues between $84 million and $87 million in Q2:FY09. However, gross margin will be negatively impacted by FX rates.

OPXT guided Q2:FY09 sales solidly above our prior and consensus estimates with expectations for a modest increase in operating expense. The company's commentary on market demand trends pointed to a positive outlook across datacom and telecom opportunities. The company also outlined a number of margin improvement steps including procurement initiatives and plans to reduce yen exposure in COGS to 60% of total by the end of year.

The stock is currently trading at 18.7x our FY2009 EPS estimate. We continue coverage of OPXT with a Hold rating and a six-month target price of $7.00.

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