I hope you received and enjoyed your new Investment Digest yesterday. Here’s a brand-new high-potential recommendation, from Ian Wyatt’s Top Stock Insights.
“Avago Technologies Ltd. (AVGO) is a well-established company with 40,000 end customers. They sell into four primary markets: wireless communication, wired infrastructure, automotive electronics and computer peripherals. Its 50 years of innovation in those segments dates back to an origin with Hewlett Packard (HPQ).
“Since separating from Hewlett Packard, Avago evolved as a business that created 6,500 products. That book is growing and new products come online every month. Attention to new product designs occurs mostly in two chief segments — wireless communication (38% of sales) and infrastructure (28% of sales). These segments operate in two strong secular trends that we like — smartphones and network expansion (more on both in a bit). Not only is the wireless communications market Avago’s biggest segment, it will likely be its highest growth segment as well. Last year the company bolstered its customer base when it achieved big contracts wins with Apple.
Growth expected in the communications segment
“In the past Apple has used technologies from Skyworks Technology, RF Devices (RFMD) and TriQuint Semiconductor (TQNT). But Avago gained market share at the expense of all three in 2011 when Apple tapped Avago to build custom technology for the iPhone 4.
“Avago delivered that technology with the ACPM-7181 — a unique and valuable part of the iPhone 4S. This custom device merged the functionality previously implemented by three components. Avago’s team achieved parts reduction by developing a custom pressure application measurement that can support 2G and 3G cellular technologies across multiple bands.
“Apple and analysts in the industry cheered Avago’s design. Francis Sideco, principal analyst in communication for HIS said, ‘Avago presently is ranked as a second-tier supplier well behind leading power amplifier suppliers. However, with the inclusion of its custom PAM (pressure application measurement) in the highly popular iPhone line, Avago now is going to be in contention to become a first-tier supplier.’
“This is an important step for Avago to blossom from a $9 billion company into a $12 billion company, which is where we think it’s heading. Avago’s key design win in the iPhone last year could make it a prime choice for future iPads and the iPhone 5.
“Even before Apple tapped it for a part last year, Avago was a solid company on a great growth trajectory. While Apple is a technology giant, it is a small potato compared to the entire communications industry. ... Analysts at Market and Market agree that network upgrades are a major secular trend. Their analysts see the global market growing from a $2.5 dollar billion business to a $262 billion business environment by 2015. That’s a 158% compound annual growth rate from 2010. This should help Avago, which supplies fiber optic transceivers for networking upgrades.
“The need for additional network capacity is primarily the result of increased handheld electronics with wireless network access. It’s devices like the iPhone/iPad and device suppliers like Avago who are creating the goods that will put the strain on the network. While the growth in the network will take five years to unfold, the growth in smartphones is here now. ...
“While the industry’s future opportunity is huge, Avago’s financials are already firing on all cylinders. Revenue was $2.3 billion for 2011, an increase of 12% from $2.1 billion in 2010. They also achieved record operating income, record total assets and paid their debt down to zero. The record profit and no debt are essential to future growth and will enable management to continue their generous cash dividend.
“Along with sturdy financials, Avago is one of the more shareholder friendly names in high-growth tech. Not only does Avago pay a 1.5% dividend, it has increased the payout during the past two years. And management declared a $0.13 dividend in March of this year. Avago paid a $0.12 quarterly cash dividend last year and it frequently buys back its shares, which is essentially another form of repayment to shareholders. A buyback doesn’t grant the shareholder more cash, but it does support the stock by decreasing shares outstanding.
“Recently, the board of directors authorized another repurchase of up to 15 million shares or about 6.3% of total shares outstanding. This was a continuation of a share purchase program from last year. What’s more interesting is that management did most of their share buying when the stock was at $33.66.
“Today, the shares trade just above the $34 level and carry a P/E of 15.5. Analysts expect Avago to earn $2.48 per share in 2012 and $2.88 in 2013. Based on those two estimates, the stock trades at 13.8 times current and 12 times forward EPS.
“The historical P/E for Avago is a tad under 16. If we apply that multiple to forward EPS, the result is a $46 price target. Currently, 16 analysts follow the stock and 14 have a buy rating with a median target price of $42. The average of the two is $44 and that is our price target. But even that target price seems low.
“I added Avago to the Top Stock Insights portfolio because of its value and its exposure to the secular growth in the wireless space. Additionally, Apple may play a huge factor in the near term value of not only the industry, but specifically Avago should it win design contracts for future iPhones and iPads. Also, Avago is shareholder friendly with a 1.5% annual cash dividend and a share buyback program; the stock is 3% above where management purchased it in the past. This Singaporean stock is off to a hot start in 2012 and we are looking for explosive gains into 2013.”
- Ian Wyatt, Top Stock Insights, May 2, 2012