Analog Devices (NASDAQ:ADI) recently had its 2022 Investor Day, and we’d like to share some valuable insights. The company highlighted its strategy to provide more comprehensive solutions, one of why management is confident it can deliver 7% to 10% revenue growth over the next five years.
This objective of strong revenue growth is likely to further improve profitability. There have also been discussions of the possibility of obtaining more than $1 billion in revenue synergies with Maxim, starting in fiscal year 2024.
Some of the most compelling targets include establishing an adjusted gross margin floor of 70% and adjusted operating margins between 42% and 50%. The free cash flow target was reduced slightly to 34-40% from 34-42%, the main reason being that ADI is looking to increase its capital expenditure to expand its production capacity.
Numerous examples were also provided showing how the company should benefit from secular tailwinds in industrial, automotive, healthcare, IoT and communications end markets.
One of our favorite things about ADI is its revenue stability and diversity, as well as its excellent profitability. Design gains are also very durable, as shown in the cohort analysis below. Impressively, around 50% of ADI’s revenue comes from products that are over ten years old. A significant part still comes from products launched before the turn of the millennium!
The huge diversification also reduces risk, with around 75,000 referrals and around 80% of revenue coming from products that individually contribute 0.1% or less. Additionally, as shown below, there is good diversification, both in terms of end market and geography.
ADI expects revenue growth to accelerate to 7-10% as it focuses more on solutions than products, as well as the fact that the company benefits from several secular growth engines. These include Industry 4.0, digitization of healthcare, vehicle electrification, renewable energy, data center growth and IoT.
ADI is a company that takes ESG commitments seriously and has a series of goals to reduce its impact on the planet.
ADI also has a positive ESG element as many of its products are part of solutions to improve sustainability around the world. A good example is the extensive use of ADI products in electric vehicles. Another area where its products do a lot of good is in network health and decarbonization.
Speaking of electric vehicles, ADI holds the #1 position in battery management systems (BMS). The electrification of transportation is a trend that will greatly benefit ADI, given that electric vehicles contain on average 3 times more semiconductors per car than regular gasoline vehicles.
In order to take advantage of these growth opportunities, ADI will need to invest significant amounts in capital expenditures. Its historical capital expenditure was around 4%, but given the acceleration in growth, the company now estimates that it will need to spend more than 4-6% of its sales on capital expenditure to open new factories. or enlarge existing ones. For fiscal years 2022 and 2023, capital spending is expected to be even higher, at high single digits.
Analog Devices has enviable profitability and, as they like to brag, they are a top player in a top industry. Its gross margins of approximately 71% approximate those of the software industry, its operating margin is nearly 2x that of the average S&P 500 company, and its FCF margin nearly 3x that of the medium company of the S&P 500.
ADI took advantage of the investor day to update its financial model. The main differences from the old one are that it sees higher operating margins, that it expects to return 100% of its free cash flow to shareholders since it is no longer necessary to reduce debt, and that capital expenditures as a percentage of sales will be higher. The company is also targeting EPS of $15 by fiscal year 2027.
The company also updated the progress of Maximum Synergies. In terms of cost synergies, it has already realized $275 million in savings and it plans to add another $125 in fiscal 2023. In terms of revenue synergies, it believes it can generate more than $1 billion over the next few years through co-designs and sales opportunities.
In terms of capital allocation strategy, ADI is heading towards a dividend with a free cash flow payout of 40-60% and increasing by 10% throughout the cycle. The rest of the free cash flow will be used for share buybacks, with $2.5 billion to be executed by the end of FY22 and another $5 billion by the end of FY24. This should result in a significant reduction in the number of shares outstanding. The company also believes that it does not need to further reduce its debt, given that it currently operates with very little leverage.
ADI’s dividend increases have been impressive, as seen below. Unfortunately, the current yield is relatively low, but the yield on cost can quickly improve as ADI continues to increase the dividend.
Analog Devices shared many interesting data points in its latest Investor Day presentation. We selected what we thought were the most relevant highlights from the event. We hope this gives a good idea of the direction the company envisions for the next few years. We think the stocks are a bit undervalued and the company will continue to see several tailwinds that should benefit the company over the next few years.