Uncertain Times Keep ADI a Hold

We reiterate our Hold recommendation on Analog Devices, Inc. (ADI - Analyst Report) as the shares have good long-term potential, but given the uncertain macro economic situation, the valuation seems fair.

Analog Devices derives around half its revenue from the industrial market, which, according to World Semiconductor Trade Statistics (WSTS) data, should continue to exhibit strong growth through 2010. The high-margin communications business has also witnessed steady growth. Analog Devices is a debt-free company, with net cash per share of $4.09. ADI is expected to grow through increased penetration of the existing customer base.

A number of factors will influence semiconductor sales in 2008. The possibility of a recession in the U.S., presidential elections in November and the Olympic games are some of the external factors. The most important internal factor is the possibility of capacity shortage for the manufacture of non-memory chips.

The Management anticipates second quarter revenue of $650-665 million (up 0.1% to 2.4% sequentially). Gross margins are expected to be in the 61% range, while operating expenses are expected to increase slightly. The GAAP earnings from continuing operations is expected to be $0.43-$0.45, while discontinued operations are expected to fetch another $0.02-$0.03.

ADI shares are currently trading at 18.1x multiple of share price to our 2008 earnings estimate (P/E). A negative mix of business affected margins in the last quarter, which is expected to remain unfavorable for the year. Although ADI has a significant presence outside the U.S., management was cautious about its expectations regarding consumer spending. We are positive about this stock, but feel impelled to echo the caution expressed by management. We are raising the target price to $38.00 (19.8x P/E).

Sejuti Banerjea contributed to the report.

Read the full analyst report on ADI