From October 29 (last Monday when we published a report on ToM) to date, the shares of NXP Semiconductors rallied over 19 per cent after reporting a satisfying quarter.

We reviewed our model of NXP Semiconductors post Q3 2018 results and maintain our BUY recommendation and 1-year price target of $93.50.

Main points from the Q3 2018 results

• Total NXP revenue came in at $2.45B, an increase of 2 per cent year-on-year, an increase of 7 per cent versus the prior quarter
o Automotive, $990M (+4% Y/Y);
o Secure Connected Devices, $717M (+1%);
o Secure Interface and Infrastructure, $511M (+5%);
o Secure Identification Solutions, $133M (-4% on lower demand)
• Gross margin came in at 53%
• Operating margin was 30%
• Earnings per share of $5.60
• $2B hit the company’s cash flow from operations due to the termination fee associated with the failed Qualcomm takeover
• Share buyback – throughout the quarter, the company returned about $4.6B to shareholders via previously announced $5B share repurchase program
• Guidance Q4 2018 - Total revenue increased from $2.315B to $2.465B

Investment rationale

NXP is a market leader in its field and designs semiconductors and software for mobile communications, consumer electronics, security applications, in-car entertainment, and networking.

In October 2016, Qualcomm had placed a bid to acquire NXP for $38 billion, which amounted to $111 per share. The bid was later increased to $127.50 per share in February 2018. However, the takeover did not go through due to increased tensions between China and the US.

Since then, the shares fell 40 per cent after the take-over was no longer on the table. Main reason being management of NXP said they did not expect to raise gross margins to the level of rivals like Intel and Texas Instruments (above 60 per cent).

Reason being that management want to retain its leading position in supplying automotive chips and grow sales by 5 per cent to 7 per cent a year between now and the end of 2021, which the company said is about 50 per cent more than the estimated growth rate of the chip industry.

We are of the opinion that focusing on increasing market share by being price competitive is more important in these markets rather than striving the hit higher margins in the short term. More and more so that trade tensions between countries are increasing.

However, the company is targeting higher margins in the years ahead. NXP also aims to boost its gross margins from the current level of about 53 per cent to 55 percent by the end of 2019 and to as much as 57 per cent by the end of 2021, while possibly selling off low-growth or low-margin businesses. We see this as a positive for the group.

We believe patience will pay off in the long term. Management confirmed that they remain committed to delivering complete solutions for their customers where they could benefit from significant cross-selling opportunities as a one-stop shop.

We believe the company’s strategy based on high relative market share will ensure high investment efficiency and consistent profitability.

Dividends

The team initiated a dividend program that is set to return $0.25 in Q418 and over the long term, represent circa 20-25 per cent of cash flow from operations.

Management outlook

• The company to grow at a 5-7 per cent top line CAGR for the next three years
• A focus on out-investing peers to achieve high relative market share of at least 50% above the next competitor in most participating markets
• Long-term financial model targets of gross margin of 53-57 per cent

Disclaimer:

This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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