Why I reduced INFN, but added to SWKS.
You may be legitimately be wondering why I reduced INFN but yet added to SWKS, when their sell-offs after earnings may be seen as superficially the same. I’ll try to explain it. You may have arguments about individual points, but try to see the entire picture. These are entirely different pictures! After all, there is a reason that INFN was off 23.6% at Friday’s close, while SWKS was off 7.0%.
Point 1
As earnings hit, INFN had a PE of 20.2. At Friday’s close their PE was 15.4.
As earnings hit, SWKS had a PE of 12.6. At Friday’s close their PE was 11.7.
Do you see anything at all about INFN that makes them worth that much more?
Point 2
Starting from FoolishErik’s incredible 10-Part Deep Dive that got me interested in this in the first place, everyone knowledgeable started off by emphasizing that INFN lived in a tough neighborhood, with tough customers and tough competition.
And, as Monkey (I think it was) pointed out: while it would be nice to put in a new system with more capacity and more speed, any customer can put off ordering and just decide to keep the system they put in three years ago for another year…or two, if they have to.
On the other hand, I have never heard anyone emphasize that Skyworks is in a tough neighborhood. Sure they have competition and customers, but it’s normal competition and normal customers.
And their customers need SWKS’s products for their products that they have to sell to stay alive! …No customer can say, “Sure it would be nice to sell some new smartphones this year, but we’ll just settle for the phones we sold three years ago and not sell any phones this year”. Their customers have to buy Skyworks products (or equivalent, if they can find them) to stay alive. No questions about not ordering them until next year.
Point 3
Skyworks had gross margins of 50.8%, up an astounding 410 basis points (4.1%), in spite of the momentary hiccup with Apple.
Their operating margins were 36.8% (33.2% GAAP). That means they did this while spending only 14% of their revenue on operating expenses (or 17.1% GAAP). That 14% of revenue covered ALL their Selling and Administrative Expense (CEO’s salary and all!) and their R&D.
Now let’s look at Infinera. Their gross margin was also 50.2%. However, while Skyworks kept 36.8% of their revenue as operating margin, Infinera kept only 12.3%. That means they spent 37.9% of their revenue on operating expenses, while Skyworks spent just 14%. They spent 2.7 times as much as Skyworks! Two-point-seven TIMES!
To put it another way, Infinera took the money they had left after cost of goods sold, and they spent over 75% of it on SG&A expenses and R&D.
Skyworks, on the other hand, took the money they had left after cost of goods sold, and they spent less than 28% of it on SG&A expenses and R&D.
Point 4
As Foolish Erik said a year and a half ago:
Infinera has so far been pouring far more money out the door than they are making through sales, with all of it going into the quest to grow the company’s sales and profitability. After 15 years of operations they are now $590M in the hole. Yes, that’s half a billion dollars. They achieved positive cash flow from operations two years ago, and were bottom-line profitable only last year.
(Now Saul back again). In a way, Infinera still has the attitude of a start-up company:
“We have a great future! Let’s just spend all the money we want to, and take lots of stock-based compensation, and simply raise more money if we need to. Operating margins aren’t really important. Earnings are okay if we make them but we’re here to have fun. Stockholders don’t matter.”
However, it’s no longer the story stock with such a great story and “a great future” that it doesn’t have to worry about earnings. Now it’s a regular company and is being evaluated according to its real earnings.
Point 5
What is Skyworks doing with all this money they are bringing in. They are paying it out to stockholders:
For the first half of fiscal 2016, we generated roughly $383 million in free cash flow, redistributing over 60% or $234 million to shareholders through our dividend plan and our share repurchase activity.
They repurchased 2 million shares in the March quarter. They doubled their dividend in 2015.
I don’t remember anything about INFN ever repurchasing shares or considering stockholders in any way.
Point 6
Skyworks told investors exactly what would happen this quarter in their fourth quarter conference call, way back in January:
…we anticipate revenue of $775 million and non-GAAP diluted earnings per share of $1.24…
…Now, despite these positive long-term drivers, this year the March quarter, which is normally a seasonally soft period, has been impacted by above normal forecast reductions and inventory adjustments at one of our top customers. This dynamic has been well documented across the supply chain over the last few weeks.
After closely analyzing the market environment, we have adopted an appropriately conservative outlook for our Q2 revenue guidance. However, through strong gross margin performance and a disciplined focus on cost, the overall impact to EPS is relatively small and our guidance represents high single-digit earnings growth on a year-over-year basis. Don will provide more specifics later in the call.
It is worth emphasizing that we are well-positioned for a strong second half of calendar '16, based on clear visibility into design wins across our flagship smartphone customers. And from this vantage point we are highly confident in our prospect for gaining dollar content within upcoming generations, putting us on track to continue delivering above market revenue growth with expanding profit margins and earnings leverage.
There was nothing new in this earnings report that warranted a sell-off.
Point 7
By contrast, the Infinera speaker seemed like a deer caught in the headlights. It was all “if” and “maybe” and “we hope” and “uncertain” and “difficult to predict” and “will depend on whether” and “lumpiness” and ……
He didn’t know when business would pick up again.
He wasn’t sure when Metro would kick in.
He had no idea why the large Transmode customer wasn’t ordering.
He didn’t know when that customer would start to reorder again.
It sounded as if he didn’t even know whether that customer had switched to another supplier, and was gone for good.
I continue to be optimistic in regard to the Transmode acquisition.
Optimistic? What does that mean!? At this stage?
He was predicting only 11% Operating Margins next quarter.
The midpoint of our projected guidance translates to a non-GAAP operating margin of 11% plus or minus…
11% for non-GAAP operating margin is terrible! And GAAP operating margin will be even less!
In closing, I remain very optimistic about the state of our business. Our customer base is healthy and broadening. Success in the short term will largely be dependent on the timing of our customers making investments in network upgrades particularly in metro and data center. While there is some uncertainty on this timing, we consider our customers making these investments a when rather than an if decision…
…among certain customers we are seeing signs of spending lumpiness, driven by uncertainty around the timing of their investments. While it is difficult to predict how long these dynamics could affect our results over the short term, the strong bandwidth demand environment… gives us confidence in our medium- and long-term outlook.
As we have stated in recent quarters, while we expect to continue to outgrow the long-haul market, our ability to continue to significantly outgrow the overall market will depend on the success of the new products we released late last year and synergies associated with selling Transmode’s products into the historic Infinera customer base.
They released the products last year, and here it is the first of May and they don’t know if they will be successful yet?
The level of trial and eval activity, along with some early customer wins, suggest that we are on the right track with these new products, though it inevitably takes time to translate these positive signals into significant revenues.
… while we are experiencing a convergence of local and macro issues that we do not see as indicative of any longer-term trends, it is challenging to predict the timing of customer spending in our industry and to determine whether this is a one quarter dynamic or one that might persist further into 2016.
We currently project non-GAAP gross margin in Q2 to be 48% …
We currently anticipate non-GAAP operating expenses to be $95 million …as we balance the need to invest in key areas that will allow us to maximize our market share opportunity with ongoing profitability. (They are worried about maintaining profitability?)
Point 8
In spite of the Apple slowdown, Skyworks was growing everywhere else. Here are some of the accomplishments I was especially impressed by:
• 16 Skyworks devices in Cisco’s latest large enterprise access point system.
• Unveiled SkyBlue™, a revolutionary technology enhancing RF power capability and efficiency in front-end solutions
• Powered Huawei’s flagship LTE platform with 10 solutions and over $9 of content
• Expanded list of OEMs leveraging SkyOne® integrated platform
• Increased content by 20% in Samsung’s Galaxy S7 smartphones
• Supported next generation launches at Lenovo, OPPO, Vivo, Xiaomi and ZTE
In this quarter alone, they landed
• a vehicle-to-vehicle communication system with Cadillac’s 2017 platform,
• GPS-based industrial tracking devices for Iotera,
• a new connected home hub for a leading online retailer,
• Cat-M solutions for machine-to-machine applications in a variety of end markets, with the world’s first front-end solution for LTE Cat-M
• connectivity modules in set-top boxes,
• temperature control systems for multiple smart home solutions,
• analog IC supporting new smartwatch platforms
We have roughly $1.2 billion in cash and no debt. We also repurchased 2 million shares of our common stock during the quarter at an average price of just over $67.50 a share.
Outlook for June quarter: At this revenue level, we suggest modeling gross margin at 51% with operating expenses flat to Q2 at approximately $108.5 million. (This) gross margin guidance implies a 200 basis point improvement from the prior year. Our strong gross margin outlook in the face of current market conditions highlights the benefits of our higher value integrated systems, along with our scale and flexible manufacturing operations.
Looking ahead, we see opportunity for additional margin improvement…. As a guideline, we recommend modeling a 60% incremental gross margin off of the third quarter baseline. We continue to target a goal of at least 53% gross margin for the company
Wow! What a difference in tone, outlook and execution between the two companies!
I hope this helps explain my decision.
Saul
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