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The Contrarian: How High Can AVGO and SWKS Fly? (AVGO, SWKS)

2017-02-23 04:04 | Network |

 The Contrarian: How High Can AVGO and SWKS Fly? (AVGO, SWKS)
(Tip:click the picture to see the big picture.)

This morning MKM Partners assumed coverage of Skyworks (SWKS​), Broadcom (AVGO​), and Qorvo (QRVO​). Analyst Ruben Roy has a $109 price target on shares of SWKS; the analyst noted SWKS currently trades at a forward 2018 P/E of 15, based on estimates of $7.07. Roy believes SWKS could see multiple expansion over the next year, due to the strength in the upcoming product cycle. The analyst also placed a $240 price target on AVGO, citing multiple expansion as well. For QRVO, the analyst set at $78 price target on the stock. Roy believes that QRVO is currently trading at a discount to AVGO and SWKS, but claimed that as management continues to execute, the multiple discount should contract. Finally, MKM started Nvidia (NVDA​) with a Neutral rating and a $100 price target.

All these firms are Apple suppliers, and the product cycle being referenced is clearly the expected release of the iPhone 8. The last major product shift for Apple was the iPhone 6, with larger screen options, especially the iPhone 6 Plus (the iPhone 7 merely improved upon the iPhone 6 specs). Below is a chart of the three companies and you can see from the start of January 2014, leading to the release of iPhone 6 in September, the stocks all saw a major run higher.

AVGO data by YCharts

This analysis will focus on SWKS and AVGO. SWKS was trading around $27.50 at the start 2014, and AVGO was trading around $52.50. Both companies were in a bullish uptrend into the summer of 2015, where SWKS topped out $110 and AVGO topped out around $145. Meanwhile, in January of 2014 analysts were looking for AVGO 2015 EPS of $3.87, which put the 2015 forward P/E for AVGO at 13.5. By the end of 2014, estimates for 2015 grew to $7.90. Meanwhile, the shares had risen to about $101, or a 2015 forward P/E of 12.8. So although the stock price of AVGO nearly doubled, so to did the analyst EPS estimates. Meanwhile, SWKS saw its forward 2015 EPS start January of 2014 at $2.80, giving the company a 2015 forward EPS of around 10. By the end of 2014, EPS estimates for 2015 rose to $5.10, while the price of the stock rose to around $75, giving the stock a 2015 forward EPS of 16.

AVGO EPS Estimates for Next Fiscal Year data by YCharts

Right now, according to YChart 2018 estimates for SWKS are $7.06, giving the stock a 2018 forward P/E of 13.5. Meanwhile, AVGO has a 2018 estimate of $15.29, giving it a 2018 forward P/E of around 13.8. Taking 2014 as a template for the current up cycle, one could argue that you will not only get multiple expansion but EPS expansion, too. As we mentioned in above, you got the EPS revision to go along multiples. And in the chart below, you can see that you didn't even need multiple expansion for the price of the stocks to rise.

AVGO EPS Estimates for two Fiscal Years Ahead, by YCharts

In the chart below, I took the data above and calculated the P/E ratios.

 The Contrarian: How High Can AVGO and SWKS Fly? (AVGO, SWKS)
(Tip:click the picture to see the big picture.)

Data Complied from YCharts

You can see the multiple expansion in SKWS and AVGO, with SWKS forward P/E growing from around 9 to as high as 16. However, you can also see that the P/E expansion didn't top out until after estimates stopped rising. Meanwhile, the P/E for AVGO pretty much stayed in a range of 11 to 15. You could argue the summer of 2015 was the end of the prior cycle, since EPS estimates stopped increased and the stocks went into a down trend. You can also argue that the multiple expansion didn't occur until the very end of the cycle, after EPS revisions stopped rising.

So what if, like the last up cycle, we don't get actual P/E multiple expansion until the end of the cycle? That would mean we could see EPS revisions upward for a time, which would put upward pressure on the stocks and keep multiples in line.

AVGO EPS Estimates for two Fiscal Years Ahead, by YCharts

In the chart above, it's plain that there haven't really been upward EPS revisions in the current cycle, for either SWKS or AVGO. Compared to the iPhone 6 cycle, we are likely in the early innings, since last time the upwards EPS revisions didn't start until after the second quarter of 2014. If we see strong EPS growth in these companies and revisions start appearing in the second quarter of 2017, you could see similar EPS growth like we did in 2014.

For argument's sake, what if we only see half the growth we saw in 2014? Could we see EPS estimates for AVGO rise from $14.68 to $22? Could we see SWKS revision rise from $7.50 to say roughly $11.25? Utilizing the current multiples of a two-year fiscal forward P/E of 13, that would put shares of AVGO around $286 and SWKS around $146. And that's without multiple expansion. What if we only see the multiple expansion later in the cycle, which was the case in the previous cycle?

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