Investor Essentials Daily

An underappreciated “roadie” provides the technical support to the IoT revolution

NXP Semiconductors N.V. (NXPI)
May 25, 2021

The spotlight of the Internet of Things (IoT) is on the tech giants like Amazon and Google that are creating consumer-facing products and software.

These advancements need a backbone and behind-the-scenes connectivity, which today’s company provides. When looking through a Uniform Accounting lens, it becomes clear the company’s services are a vital piece of the IoT puzzle.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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When people think of the Internet of Things (IoT), they often focus on the excitement around innovation and technology advancements driven by the big names.

Companies like Amazon (AMZN), Google (GOOGL), and Tesla (TSLA) take all of the credit on blogs and panel shows like CNBC. It is easy to focus on companies like these when investing around the next wave of connectivity and data-driven products.

IoT is an all encompassing phrase to indicate physical devices connected to the internet. For the IoT to work, everyday products would need to connect with each other and the internet seamlessly.

For example, appliances and products in homes such as refrigerators and thermostats can all be under one system that is connected to the internet. With one app, people can control all the appliances in their house.

This level of connectivity even allows individuals to connect smart cars and other types of technological advanced products to the internet.

By connecting all of our devices together, people are able to automate parts of their lives they otherwise wouldn’t be able to.

However, people today looking for the winner in the space may end up missing the underlying point of IoT.

As the IoT space develops and becomes more prominent, the backbone of connectivity becomes vital to the process.

Without the ability for all of these devices to connect to each other, they are effectively useless. The smart products may be the stars of the show, but the firms ensuring connectivity are the “roadies.”

The companies that do work behind the scenes have to make sure devices are connected to WiFi and the internet. They also need to generate all the signals and data that is needed to make IoT popular.

One of the companies at the heart of this backbone of the IoT space is NXP Semiconductors (NXPI).

On a higher level, the company makes the chips that help connect devices to your home WiFi. It also makes sensor chips that help IoT products get the data they need to be able to conduct powerful tasks.

The company’s services are a crucial part of the future of the IoT space.

As a result, investors would expect that a company so essential to a booming industry would be printing money.

On an as-reported basis, the company generates exceptionally weak profitability. The company generates return on asset (ROA) levels consistently below 2%, not even meeting its cost of capital.

See for yourself below.

In reality, this is not an accurate picture of NXP Semiconductor’s profitability.

The company is not generating returns below its cost of capital. In reality, NXP Semiconductors is posting robust returns.

For example, the company’s returns in 2020 were near 20% levels, well above the cost of capital and corporate averages of 12%.

When looking through a Uniform Accounting lens, it becomes clear that NXP Semiconductors is much more profitable than it initially appears.

As the company provides an essential service to the tech industry, it earns a premium return through its connectivity services.

SUMMARY and NXP Semiconductors N.V. Tearsheet

As the Uniform Accounting tearsheet for NXP Semiconductor N.V. (NXPI:USA) highlights, the Uniform P/E trades at 17.1x, which is below the global corporate average of 23.7x, but around its own historical average of 16.2x.

Low P/Es require low EPS growth to sustain them. That said, in the case of NXP Semiconductors, the company has recently shown an 11% Uniform EPS decline.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, NXP Semiconductors’ Wall Street analyst-driven forecast is a 90% and 5% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify NXP Semiconductors’ $200 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to grow by 7% annually over the next three years. What Wall Street analysts expect for NXP Semiconductors’ earnings growth is above what the current stock market valuation requires in 2021 but below that requirement in 2022.

Furthermore, the company’s earning power is 3x above the long-run corporate average. Also, cash flows and cash on hand are twice its total obligations—including debt maturities, capex maintenance, and dividends. Meanwhile, intrinsic credit risk is 110bps above the risk-free rate. All in all, this signals a low dividend and credit risk.

To conclude, NXP Semiconductors’ Uniform earnings growth is well above its peer averages, and the company is trading in line with its average peer valuations.

 

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research