Finally, Investor Validation Arrives for Analog Devices

Investor validation has been slow in coming for the strategic and product reorganization Analog Devices Inc. (NYSE: ADI) began implementing about three years ago.

On Tuesday, Nov. 23, however, the sweet scent of shareholder affirmation rose strongly even in a tumultuous market, pushing up the analog semiconductor company's stock price to $36.07, its highest level in more than two years. The stock later slipped 1 percent amid a general sell-off.

Analog Devices shares have now risen 37 percent in the last year, and, in my opinion, they still have solid legs to climb higher in the months ahead. While sales may weaken sequentially in the December and March quarters, I fully expect Analog Devices to remain the must-watch stock among its peers.

Its guidance for the December quarter is for some seasonal weakness with customers shifting orders around. Yet, "2011 will be a solid year, according to indications from our customers," CFO David Zinsner said in an interview. I concur. I also believe investors will reward the company with even higher valuation in 2011.

Here's why: Analog Devices is one of the premier plays in the analog IC market, but beyond the strength of its sector the company has implemented some fundamental changes to its operations that in the future will help it maintain margin growth, steady sales improvement, and rising goodwill for dependable supplies. In a sector marked over the last two years by fears of shortages, extended lead times, and component allocations, the ability to guarantee supply to harried OEMs cannot be overemphasized.

In the fiscal fourth quarter ended Oct. 30, Analog Devices' gross profit margin swelled to 67 percent, from 56 percent in the year-ago quarter. Fiscal 2010 gross profit margin also rose about 10 percentage points to 65.2 percent from 55.5 percent in fiscal 2009. The increase came on a 37 percent surge in revenue to $2.76 billion, the highest the company has posted in at least five years. Finally, it seems, Analog Devices has all its engines firing at full blast.

"Driving our success in the fourth quarter and throughout the entire fiscal year is our operational model, which we structured to get the upside while simultaneously protecting against the downside," said Jerald Fishman, CEO of Analog Devices, during a conference call. "Our new organizational structure increased our alignment with customers; heightened our understanding of their applications and their systems architecture; enabled us to provide much more complete solutions; and helped us further refocus on our investments on those products and those markets where our innovations have sustainable value and we can get paid for them."

The seeds of the company's past and future successes are embedded in Fishman's summary. Analog Devices has been focusing on proprietary technology and also on production efficiency. Zinsner said the company kept lead times at six weeks to eight weeks over the last quarters even as some competitors struggled with more extended delivery times. As the high-tech sector heads into the seasonally weaker first quarter, and with visibility still cloudy due to wariness on the part of OEMs, Analog Devices will "not panic in any way," he asserted.

To protect its margin in consumer, Analog Devices, according to Zinsner, will be aligning itself even more closely with partners "that are doing advanced technology products and we can earn the margins that we get for industrial and communication infrastructure products."

It's not unlikely that Analog Devices, like its competitors, will come up against a market downturn in the future, a development that could hurt carefully laid out plans. By my reckoning, however, Analog Devices' track record of efficient delivery even when demand and supply were out of sync has given it extra points with customers. The coming challenge the company faces is ensuring it does not mess up that carefully cultivated image.

"We will bask a bit in the glory of what we did over the last year," quipped Zinsner, before returning almost as quickly to the cautious and deliberate tone that has characterized Analog Devices' operation over the years. "But we will still be tight with operating expenses and committed to efficient production, because once lead times get squeezed, things spiral out of control."