ADI’s profitability trend
In the previous part of the series, we saw that Analog Devices (ADI) is likely to report strong revenue growth in fiscal 4Q16 driven by seasonal demand from its key customer Apple (AAPL). High demand from Apple was the same reason why ADI’s fiscal 3Q16 earnings rose.
ADI supplies analog chips that are manufactured in old fabrication facilities that have already been paid off. Thus, the company enjoys a high gross margin of above 60%. The margin isn’t very volatile and moves in the range of 62% to 66%. However, there’s major variation in its operating margin, which hovers between 27% and 36%. Let’s look at the margins ADI could report in its fiscal 4Q16 earnings.
As seen in the above graph, ADI’s gross margin was high in fiscal 2Q and 3Q as the company stocked up on orders from Apple. However, the margin could fall slightly in fiscal 4Q as the seasonal demand fades.
ADI expects its gross margin to fall from 66% in fiscal 3Q16 to 65.5% in fiscal 4Q16. The company’s gross margin is higher than Maxim Integrated’s (MXIM) and Texas Instruments’ (TXN) gross margins of 64% and 62%, respectively.
After the acquisition of Linear Technology (LLTC), which has a gross margin of above 75%, ADI’s gross margin could rise to 69%.
While the gross margin may contract, ADI’s operating margin may expand or remain flat at 34% in fiscal 4Q16 as the company increases its operating expense from the fiscal 3Q16 level of $277.8 million. The company launched new products in the industrial and IoT (Internet of Things) space. This could probably increase its development and marketing expenses, thereby increasing its operating expense.
ADI’s operating margin of 34% is less than Texas Instruments’ operating margin of 37.9%. After the acquisition of Linear Technology, ADI’s operating margin could expand to 38%.
Next, we’ll look at ADI’s four business segments and the factors that could drive growth in each of these segments.