Avago Technologies Ltd. (AVGO): Earnings Analysis

Valuation Drivers

Avago Technologies Ltd.’s current Price/Book of 3.5 is about median in its peer group. We classify AVGO-US as Harvesting because of the market’s low expectations of growth (PE of 15.2 compared to peer median of 19.7) despite its relatively high returns (ROE of 25.4% compared to the peer median ROE of 12.4%).

The company has a successful operating strategy with above median net profit margins of 23.8% (vs. peer median of 11.1%) and relatively high asset turns of 0.9x (vs. peer median of 0.7x). This suggests that the company has a dominant operating model relative to its peers. AVGO-US’s net margin is its highest relative to the last five years and compares to a low of -14.4% in 2007.

Economic Moat

The company enjoys both better than peer median annual revenue growth of 1.2% and better than peer median earnings growth performance 2.0%. AVGO-US currently converts every 1% of change in annual revenue into 1.7% of change in annual reported earnings. We view this company as a leader among its peers.

AVGO-US’s return on assets is above its peer median both in the current period (21.2% vs. peer median 8.1%) and also over the past five years (13.2% vs. peer median 6.3%). This performance suggests that the company’s relatively high operating returns are sustainable.

The company’s gross margin of 54.0% is around peer median suggesting that AVGO-US’s operations do not benefit from any differentiating pricing advantage. However, AVGO-US’s pre-tax margin is more than the peer median (24.7% compared to 11.1%) suggesting relatively tight control on operating costs.

Growth & Investment Strategy

While AVGO-US’s revenues growth has been above the peer median (16.8% vs. 7.4% respectively for the past three years), the stock’s PE ratio of 15.2 is less than the peer median. This implies that the company’s earnings are peaking and the market expects a decline in its growth expectations.

AVGO-US’s annualized rate of change in capital of 13.9% over the past three years is around the same as its peer median of 13.9%. This investment has generated a better than peer median return on capital of 26.5% averaged over the same three years. The greater than peer median rate of return suggest that the company may be under investing in growth.

Earnings Quality

AVGO-US has reported relatively strong net income margin for the last twelve months (23.8% vs. peer median of 11.1%). This strong margin performance was accompanied by a level of accruals that was around peer median (5.5% vs. peer median of 6.2%) suggesting that the reported net income is supported by a reasonable level of accruals.

AVGO-US’s accruals over the last twelve months are positive suggesting a buildup of reserves. However, this level of accruals is also around the peer median and suggests the company is recording a proper level of reserves compared to its peers.

Trend Charts

Company Profile

Avago Technologies Ltd. designs, develops and supplies broad range of analog semiconductor devices with a focus on III-V based products. The company’s product portfolio is extensive and includes 6,500 products in four primary target markets: wireless communications, wired infrastructure, industrial and automotive electronics, and consumer and computing peripherals. Its applications for products in these target markets include cellular phones, consumer appliances, data networking and telecommunications equipment, enterprise storage and servers, power generation and renewable energy systems, factory automation, displays, optical mice and printers. The company was founded in 1961 and is headquartered in Singapore.

Disclaimer

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By: capitalcube