Analog Devices' Tumble Gives Value Investors a Buying Opportunity
Analog Devices (ADI) fell over 5% by midday Wednesday, Aug. 17, to $169.01 after reporting stellar revenue and free cash flow (FCF) for its fiscal Q3 ending July 30. As a result, ADI stock now presents a value buying opportunity with its huge FCF, a 1.80% dividend yield, low P/E metrics, and massive buybacks.
The chipmaker reported that it made a record $3.11 billion in revenue for the quarter and also generated $1.083 billion in FCF. That represented a record 35% of its sales for the quarter. The company used this FCF to buy back a record amount of shares ($906 million) for the quarter and $4.355 billion worth over the past year. So why is the stock down so much?
Sell On the News
The developments today have all the markings of “Buy on the rumor, sell on the news” action. Some wrote that the company seemed to waiver on its prospects for future revenue developments. Management said that it warned of economic uncertainty in the earnings conference call.
But this possibility so far has not filtered down to analysts' revenue and earnings estimates. In fact, the company itself said it expects that revenue in its final Q4 fiscal quarter will be between $3.05 billion and $3.25 billion.
So at the midpoint, this will bring its total revenue for the year ending Oct. 30 to $11.916 billion, as its 9-month revenue is already at $8.766 billion.
FCF Forecasts
Moreover, assuming it makes an FCF 35% margin its total FCF for the year will be a record $3.76 billion, as it has already generated $2.658 billion in FCF in its 9 months. On top of this if analysts' forecasts for 2023 revenue at $12.35 billion come to pass Analog Devices could produce an even higher level of FCF.
For example, if its 35% FCF margins hold up over the coming year, free cash flow could reach $4.3225 billion. That could end up pushing ADI stock even higher.
Where This Leaves ADI Stock
For example, let's assume that the market may be willing to value ADI stock's FCF at a 4.0% FCF yield. This is the same as multiplying the FCF by 25x (i.e., 1/0.04 = 25). So the $4.3225 billion in 2023 forecast FCF results in a target market capitalization of $108.625 billion. This is 23.5% over its market cap today of $87.9 billion (i.e., assuming 520 million shares outstanding at $169.18 per share).
In other words, even using conservative analyst estimates of revenue and a 35% FCF margin, ADI stock is worth at least $208.94 per share or 23.5% over today's price.
Moreover, as Analog Devices is buying back huge amounts of shares, $4.355 billion in the last year alone or almost 5% of its present market cap, investors can expect to see a lower share count. This feeds through to higher earnings per share, and dividends per share and will help act as a supply catalyst to pushing the stock towards its inherent value.
The bottom line is that today's price decline looks like a good buying opportunity for value investors. Its stands on a forward P/E of just 18.2 x earnings, a 1.80% dividend yield and a price target that is at least 23.5% higher than today.
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