Skyworks Solutions Could Be Headed Skyward

 | Jan 19, 2017 | 10:00 AM EST
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In the last three months, shares of Skyworks Solutions (SWKS) have been flat, but the stock is up around 30% in the last year. Can Skyworks breakout and head skyward?

Skyworks is scheduled to report first quarter fiscal 2017 results on Thursday after the market close. Analysts expect the company to report earnings of $1.58, down 1.3%, on sales of $902.7 billion, down 2.6%. This will be the third straight quarter of declining sales and earnings.

Could this also be the quarter that breaks the stock out of its trading range?

After Skyworks reported fourth quarter results in early November, management raised first quarter guidance. The company anticipates first quarter revenues of $894-911 million vs. the $893 million consensus estimate. Earnings per share are expected to be $1.58.

Last year, an inventory correction related to the iPhone 6S caused a shortfall in earnings and revenue, but going forward stronger demand for the iPhone 7 and later this year the iPhone 7S should help drive revenue and earnings higher.

Skyworks derives approximately 75% of its revenue from mobile handsets and about 40% of revenue directly from Action Alerts PLUS portfolio holding Apple (AAPL) .

By some estimates, Apple had two million fewer units in the channel because of the timing of the product announcement. But that should clear up in the December and March quarters, as sales normalize. Last quarter, Apple sold 45.5 million units, down 5%, but iPhone 7 sales are expected to pick up into the New Year.

Analysts expect Apple to sell more than 230 million iPhones in fiscal year 2017 (ends September) and more than 240 million units in 2018, before sales begin to slow.

Besides shifting inventory, investors are concerned that some of Skyworks radio frequency (RF) filters are not competitive with others in the industry. Skyworks lacks a premium bulk acoustic wave (BAW) filter.

Qorvo (QRVO) and Broadcom (AVGO) are leaders in premium filters and investors are concerned the company will be edged out of the business by aggressive competition. RF filters are some of the most critical components of wireless communications.

In terms of valuation, the stock is trading at a discount to the semiconductor group because of its poor quarterly track record, but I expect that to change.

First, the company faces easier comparisons with the previous quarters. For example, fiscal 2016 revenue was up just 0.8% to $3.5 billion. Fiscal 2017 should be up a little over 8%. Skyworks should easily beat the next few quarters.

Second, the company is fantastically profitable and strong revenue growth will drive big changes in earnings. Skyworks ended 2016 with an operating margin of 37.8%. If revenue jumps 8%, earnings should be up double digits.

And finally, new products offer the opportunity to drive higher gross margins. Several types of RF filters that only Skyworks makes are becoming very important in the data transmission field. Skyworks could expand its margins from 51% to 54% over the next few years as these products catch on.

If Skyworks can get its act together this quarter and beat the analyst estimate, I think it would go a long way in restoring confidence in the shares.

Fiscal 2017 revenue should increase at least 8% (and probably higher, based on Qualcomm's strong growth). And with just 8% revenue growth, EPS should rise 10-12%, to $6.13.

Right now, Skyworks is trading at around 12.5x, so it wouldn't be out of the ordinary for the stock to trade up to 15-16x as investors get more confident regarding iPhone 7 sales.

If I'm right, the shares should begin to head skyward.

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