(By
Brian Colello, CPA) The
analog chip industry has undoubtedly encountered a mild slowdown,
starting in June 2011 and accelerating through August as a shaky
European economy and the United States debt downgrade led to global
macroeconomic uncertainty.
While it still remains to be seen how much better or worse the global
economy (and, in turn, chip demand) will get in the coming months, we
believe that several high-quality analog and embedded chipmakers are
trading at attractive valuations today. Specifically, we have our eyes
on Analog Devices (ADI), Linear Technology (LLTC), Microchip Technology (MCHP), Maxim Integrated Products (MXIM), and Texas Instruments (TXN)
within the space. We didn't see much of a margin of safety in these
stocks in better times, but many of these stock prices have fallen about
15% since May.
Several of these firms have narrow or wide economic moats, generate
healthy free cash flows, and offer nice dividend payouts. More
importantly, regardless of the depth of the current chip industry
slowdown, we believe that each of these firms will be able to weather
the storm.
After suffering from a severe downturn stemming from the credit
crisis in late 2008 and early 2009, the chip industry was on a tear in
late 2009 and most of 2010, as most firms were reporting record-high
revenue levels, boosted by favorable technology trends such as
smartphone adoption, wireless infrastructure build-outs, and increased
silicon content in automobiles. Business slowed down in late 2010 and
early 2011, reverting back to what appeared to be normal seasonal
patterns. However, the tragic earthquake in Japan in March 2011 has
caused some disruptions and choppiness within the chip supply chain.
Some firms suffered from fewer chip orders, either because of lower
production or because their customers couldn't get enough parts from
other suppliers in order to satisfy their production. On the other hand,
some firms saw a short-term boost in chip orders in March/April, as
customers wanted to make sure they had enough chip inventory on hand in
order to complete their products.
Layered on top of these disruptions was the rise in global
macroeconomic uncertainty in the months of August and September. The
usual supply chain ups and downs that determine the near-term health of
many chipmakers now appears to be a secondary issue, as the bigger
concern is the overall health of the global economy. Industries with
characteristics of long product life cycles and hefty capital spending,
such as industrial, auto, and wireless infrastructure, appear to be
cancelling or pushing back their spending until there is more certainty
in the global economy.