Analog Devices Extends Rally: Signals Start to Cyclical Recovery

Key Points

• Analog Devices has a better-than-feared quarter and indicates the start of a cyclical recovery. 
• Cash flow and capital returns are robust and will continue this year. 
• Analysts are leading this market to new highs: a 10% to 20% upside is still possible. 

Analog Devices NASDAQ: ADI share prices are surging because a trough is in place, and the outlook is robust. The FQ2 results and guidance for FQ3 aren't robust but show markets stronger than expected, and AI supports the pivot back to growth. End-market inventory normalization is expected for semiconductors in the current quarter, leading to a cyclical recovery for the business. Revenue and earnings are expected to grow sequentially in Q3, return to YOY growth in Q4, and accelerate in 2025. 

Analog Devices Stock Rockets Higher on Better Than Expected Results

Analog Devices struggled in FQ2, but the results were better than feared. The company reported $2.16 billion in net revenue for a contraction of 33.7% but outpaced the consensus estimate by 220 basis points. Weakness was seen in all end markets, led by a 45% decline in communications and a 44% contraction in Industrial. The Industrial segment accounts for more than 55% of the total, so normalization in this market is critical to long-term growth. The Automotive segment, 22% of the net, contracted by 10%, while the Consumer segment contracted by 9% and is 8% of the net.

Margin is another mixed bag of news: gross and operating margins contracted by quadruple-digit basis points on deleveraging and inventory management. However, the net results are better than feared, and the adjusted EPS is $1.40, down 50% compared to last year. That's 13 cents ahead of the consensus, outpacing the top-line strength, and results are expected to improve in FQ3. 

Guidance is favorable, continuing the trend set in Q2. The company guided revenue and EPS above the consensus targets and may exceed the forecast. The company says new orders are improving, giving them optimism a meaningful recovery is in play. Due partly to end-market normalization, the recovery is also supported by AI and the shift to the edge, where Analog Devices is a leader in data creation and connectivity. 

Analog Devices is Levered for Shareholder Success

Analog Devices uses some leverage in its operations, but the amount is insignificant. Long-term debt is less than 0.2X equity with robust cash flow to support balance sheet health despite the downturn in business. Balance sheet highlights at the end of Q2 include an increase in cash, current and total assets, offset by an increase in debt that left equity flat compared to last year. The takeaway is that dividends and share repurchases are reliable and will continue in 2024. 

The dividend is worth about 1.7%, with the stock trading near 36X earnings, a high valuation supported by the growth outlook, dividend payout ratio and high distribution CAGR. The company has increased the distribution for twenty-two years and only pays 60% of this year's earnings outlook. That figure falls to 48% versus the 2025 outlook, suggesting aggressive double-digit increases will continue, and earnings growth is expected to be sustained through 2026.  

Share repurchases are substantial. The company uses share-based compensation but more than offsets it with buybacks. Buybacks reduced the average count by 2% in FQ2 and should continue unabated. 

ADI Stock Surges to New High, Led by Analysts

The analysts set ADI stock up for its post-release surge by initiating new coverage and lifting existing price targets days before the release was due. The activity suggests a move to the high end of the expected range is likely. The high target of $254 is among the more recently set and implies another $20 or about 10% upside on top of the post-release price surge. The analysts will likely continue the trend and revise the range higher because the company indicated a pivot back to growth and expects accelerating growth.