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Skyworks: A Fast Growing Value Stock With Enormous Potential

Standing in line at the Apple (AAPL) store recently, waiting for the latest iPhone, I thought back to 2007.

It was a line outside the door of an AT&T store on a hot June day here in Baltimore that I was in that day. It wasn't a huge line - maybe 50 people - but the anticipation was evident. The first iPhone was launching that day, and pretty much anyone who followed tech had a strong sense of the possibilities it represented.

And boy, did it ever deliver!

I thought about this and my mind wandered to the phone I carried on that day. It was a Motorola V230 flip phone. You could make calls on it. You could tell the time on it. If you were extremely patient, you could get the O's score on it. To text you had to punch a number key multiple times to find the symbol you were looking for.

In short, June 26, 2007 might as well be a revolutionary holiday for the tech industry. Think of how much has changed so dramatically since then. Back then mobile data was hardly a thing. Today we use our cell connections more for text, Facebook, Youtube, Twitter, Uber, Snapchat, and numerous other things than we do for voice... by a WIDE and growing margin, too.

And the applications for always available cellular connectivity are almost endless. We're just seeing the start - industry analysts expect 50%+ *annual* growth in mobile traffic over the next 3-5 years! Today's stock is well positioned to capitalize on this still emerging market. Let me tell you about Skyworks Solutions (SWKS), a current member of both our Magic Recipe and Quality Growth Spells.

Enabling Small, Thin Wireless Devices

Skyworks Solutions is a semiconductor company that develops and sells integrated solutions for wireless connectivity. Their products allow customers to develop ever smaller and thinner devices with multiple different connectivity options, in a power efficient manner.

Skyworks has 3 general groupings of product sales. Integrated Mobile Systems consists of the chipsets just mentioned for smartphones and tablets and comprises nearly 60% of sales. Broad Markets are the company's component sales into the evolving "Internet of Things" (IoT), a 'broad' term referencing the vast array of devices using wireless communications, including automobiles, wearables, connected home devices, industrial equipment, etc. Broad Markets is just over 20% of sales. The remaining 20% come from Skyworks' older business selling power amplifiers, a key component used to increase signal strength in order to improve reception.

Growth Opportunities Galore

Maybe the most attractive aspect of SWKS is its growth potential.

Today, and for the near future, mobile phones represent the primary growth catalyst. Specifically, Skyworks stands to benefit from worldwide adoption of 4G LTE cellular networks. Consider that in the U.S., LTE adoption is just over 70%, while in China it remains under 25% and in India less than 2% of mobile subscribers have an LTE plan! With that backdrop, consider that Skyworks can generate $3-4 per LTE device while for 3G that figure is closer to $1.25, and it is clear that this is a big opportunity.

IoT

Longer-term, the "Internet of Things" represents a massive potential market. Some research firms have projected over 50 billion connected devices in 2020, up from about 18 billion this past year, a compound annual growth rate of 22.5%. The possibilities are staggering. When you think about it, virtually all of the devices pointed towards the big upcoming trends require constant connectivity - self-driving electric vehicles, drones, wearables, the "smart home", the "smart grid", and so on. All of these represent possible design wins for Skyworks.

Current estimates for Skyworks has the company pegged to deliver over 15% earnings growth annually over the next several several years. With such immense and long-tail markets, I think these estimates are realistic and, quite possibly, conservative.

Other Reasons To Like Skyworks

It is totally reasonable for an investor to ask the question: how long can a semiconductor company maintain a technical advantage? I asked it myself. But Skyworks is clearly winning. Not only has the firm generated tremendous growth over the past 3 years (22% CAGR), but it has done so while increasing gross margins from 42.5% in 2012 to about 48% last year - and they continue to rise. Returns on invested capital have soared from 13% to 36%. Skyworks has consistently won slots from all major device makers, including Apple and Samsung. The numbers tell the story here - no competitor has been able to challenge Skyworks in integrated connectivity, yet.

Financially, we've got a rock solid outfit. The balance sheet carries over $1.2 billion in cash without any debt whatsoever. Free cash flows came in at over $830 million last year, a 22% rise from 2014. Skyworks almost tripled its dividend in 2015, and yet still pays out only 15% of its free cash flow for it (the yield is 1.8%).

Management is also a strong point. CEO David Aldrich has been on the job since 2000 and has over 20 years with the company. Under his leadership, Skyworks has increased its revenues at a 21% compound annual rate while securing a "top dog" status, keeping share count dilution low, maintaining an enviable financial position, and having its stock rise over 700%. We can't ask for much more than that.

Risks

There are two big risks I see in Skyworks.

The biggest risk is customer concentration. This is a difficult one to avoid when selling into the mobile phone market, which is dominated by just a few large players. Foxconn, which builds Apple's (and other's) devices, accounted for 44% of 2015 revenue, with about 3/4ths of that likely coming from Apple alone. Samsung is a near-10% customer. Losing Apple would be a major hit to the company and the stock, and considering Apple's chip ambitions, this is no idle risk.

Customer concentration like this also creates pricing risk. If you are an operations manager at Apple, you could look at Skyworks, see you are a third of their business, and have every reason to squeeze the company on price - particularly if there is a reasonable alternative in the market. Which leads us to...

... Competition. Don't think for a moment that there are not numerous large communications semiconductor firms looking at Skyworks' margins and chomping at the bit for a piece of the pie. Qualcomm (QCOM) already has competing (although currently inferior) products in the market, and is a highly capable and well-funded competitor. Any investor in Skyworks would have to keep a close eye on margins to identify if and when the company's competitive standing is starting to weaken.

Conclusion

It is quite rare to see any stock pop up in both the Magic Recipe and Quality Growth Spells, with one being a value screen and the other a growth screen! But that is what we have with Skyworks today. All of this growth potential, financial strength, competitive edge, and superior management comes at an earnings yield of just 10.3%, well above the market's average of about 7%. If you take forward 2016 estimates, the earnings yield is positively cheap at 11%, or a forward P/E ratio of just 10.7!

That seems like quite the bargain. There are certainly risks in Skyworks to be aware of, but the opportunity is large and there will be plenty of business for more than just one player. I feel the stock could be worth up to $100 per share.

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