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From the Survey: Linear Technology
Linear Technology (LLTC) designs and manufactures high-end analog (a.k.a. “linear”) semiconductors, which handle real-world phenomena, such as sound, light, temperature, pressure, weight, position, and speed. With the market’s deluge of trendy digital products, consumers sometimes mistake the term analog for an outdated technology. On the contrary, not only are analog chips required in many everyday products, such as autos and kitchen appliances, but they are essential to such high-growth segments as smartphones, multimedia players, HD TVs, gaming systems, and digital cameras.
The technology sector is going through a bit of a soft patch, due in part to what appears to be a slower PC upgrade cycle and increased pricing pressure. Modest downward earnings revisions would not be a surprise in the near term. In Linear’s case, though, we think this would be fairly minimal. True, bookings have slowed a little, but we think this is due to an adjustment in customer lead times back toward historical levels. In the past couple of quarters, customers have gone from ordering 10 weeks in advance of needing the product, to eight weeks. Historically, that lead time is closer to four to six weeks. The resulting softness from this transition should be only temporary. However, there’s a chance that end demand is slowing, and if that’s the case, the stock would most likely experience some pressure. On balance, however, we believe Linear is the best positioned among the semiconductor companies we follow to weather this possible headwind.
A couple of additional things appear to be in Linear’s favor. It tends to be less prone to supply shocks, thanks to management’s adeptness at controlling channel inventories. Second, its portfolio, at 4,700 products, is diverse, and is sold to more than 15,000 original equipment manufacturers operating in a wide range of industries over a broad geographic footprint (revenues generated overseas were 72% of the total in fiscal 2010).
Over the past six months, chip stocks have lagged. The industry, as measured by the SPDR Semiconductor ETF (XSD), has underperformed the tech-heavy NASDAQ by three percentage points. But Linear has outpaced the latter index by a factor of two-to-one.
As 2011 approaches, we are cautiously optimistic. We are calling for GDP growth of 2.0%-2.5%. Consumer and corporate IT spending should be sufficient to expand the company’s top and bottom lines by strong double-digit percentage rates in the fiscal year ending June 30, 2011. Strong profit growth ought to carry into the years to come, as well. Given this bright outlook, we consider LLTC shares a good selection for those with a long-term view.
Profits - A Good Track Record
The company has benefited from one of the more astute management teams in the business. Even during the best of times, Linear has maintained tight cost controls, leading to preservation of its wide profit margins - the highest of any chip firm – which positions it well for those times whenever conditions do worsen. For example, although the recent recession cut revenues by about 20% in 2009 for many of the analog chipmakers, Linear’s profit margins held at 93% of the prior-year level, versus only about 70% at main rivals Texas Instruments (TXN) and Analog Devices (ADI). And Linear accomplished this without compromising research and development efforts. Given its track record and limited debt load, the company should be able to maintain or increase its high profitability level.
Expansion Prospects Appear Good
Ongoing innovation yields electronic devices of increasing complexity, which is giving rise to a myriad of new applications. Auto manufacturers, for example, are incorporating more electronic circuitry in cars, both under the hood and in the dashboard. Features once considered extras, like navigation systems and anti-lock braking systems, are increasingly becoming standard. Computers are now routinely integrated into mechanisms and systems (such as elevators, for example) that were, until fairly recently, only mechanical in nature. Increasing competition drives firms to differentiate their wares with extra features. Demand for linear chips, which are a necessary counterpart to their digital cousins, stands to benefit from these trends.
Greater Price Stability
Analog chips are usually made for a very specific function, so they are not the commodity businesses, which are vulnerable to price swings, that their digital counterparts are. This is particularly true for the high-end market, where Linear dominates.
Barriers To Entry
The creation of analog chips requires more from the engineer than does the digital design process, which can be significantly aided by software automation tools. The pool of engineering talent required for high-end applications is relatively small, so the potential threat of new competitors is relatively low.
In summary, there appears plenty of cash flow and profit-expansion potential for Linear, which stands to benefit from several high-growth areas, especially from developing markets, in the coming years. But the chip industry is inherently volatile. The company traditionally has been dependent on orders booked and shipped in the same quarter.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.