Avago Promoted to Strong Buy - Analyst Blog

On May 15, Zacks Investment Research upgraded leading analog semiconductor manufacturer Avago Technologies Limited AVGO to a Zacks Rank #1 (Strong Buy) from a Zacks Rank #2 (Buy) largely on the back of strong long-term fundamentals buoyed by the acquisition of LSI Corporation.

Avago's share prices have steadily been on the uptrend over the past one year and have more than doubled for a healthy year-over-year return of 100.3%. The stock is currently trading at a forward P/E of 22.3x and has long-term earnings growth expectation of 15.4%.

Why the Upgrade?

Avago recently completed the acquisition of LSI for $6.6 billion in cash. Avago acquired LSI to diversify its existing business line from wired infrastructure, wireless and industrial businesses into the storage chip market. The strategic move was aimed at augmenting its revenues, as the industry braces for more consolidation amid a challenging macroeconomic environment.

With annual revenues of approximately $5 billion, the combined company is expected to be one of the behemoths in the semiconductor industry, offering a complementary yet diversified product portfolio to a wider range of customers. Leveraging on economies of scale, Avago is expected to benefit from rapid increases in data center IP (Internet protocol) and mobile data traffic, to emerge as the undisputed leader in the enterprise storage market.

In addition to cost synergies from a combined resource pool as the cost of designing and building semiconductors rises, the acquisition is likely to improve the operating margin of the combined company, creating greater scale to further drive innovation into the datacenter. The transaction is expected to be accretive to Avago's free cash flow and recurring earnings, leading to annual cost savings of $200 million by fiscal 2015.

With the acquisition, Avago has replaced LSI on the S&P 500 after the close of trading on May 7. This has further raised investor confidence, who seek to own blue-chip stocks.

Estimate Revisions

Over the last 7 days, the earnings estimates did not show any upward or downward revision for 2014. Despite the lack of estimate revisions, we envision an uptrend for the stock backed by its strong growth potential.

Other Stocks to Consider

Other stocks worth considering in the industry include Advanced Semiconductor Engineering Inc. ASX, Alpha & Omega Semiconductor, Ltd. AOSL and Amkor Technology, Inc. AMKR, each carrying a Zacks Rank #2 (Buy).