Avago Remains Undervalued

NEW YORK ( TheStreet) -- For many investors 2012 will be remembered as the year that chips got eaten. With a few exceptions such as Qualcomm ( QCOM), one can point to any name within the group and present a legitimate argument of why that stock might be undervalued. Avago ( AVGO) would make my list.

Although the company is not as highly regarded as other names such as Broadcom ( BRCM), Avago enjoys similar advantages, including having strong ties in the mobile devices market where two of its biggest customers are Apple ( AAPL) and Samsung. And after delivering a strong fourth quarter, investors would be wise to place this stock on their short lists of outperformers for 2013.

Avago ended the year with some "mixed" results. Although revenue dropped 1% year-over-year, the company was able to improve sales sequentially by 2%. Likewise, when compared to the July quarter, Avago's wireless segment soared 30% -- helped by strong demand from its two most important customers in Apple and Samsung.

On the other hand, the company continued to struggle with poor demand on the wired side of its business as sales plummeted 8% -- hurt by weak carrier spending. However, the company did manage to report in-line performance in terms of profitability, albeit a lot of room for improvement remains.

Disappointingly, gross margin fell 40 basis points year-over-year. Sequentially, this was also worse by 30 basis points. But Avago did manage to grow its operating income by almost 10% while making close to a 2-point improvement in operating margin.

Over all, this was a quarter of "taking the good with the bad." While there wasn't a lot to write home about, on a relative basis Avago did quite well. Likewise, I believe there are plenty of reasons for optimism, including an expected rebound in Avago's industrial/auto segment, which saw revenue plummet during the quarter by 11%.

Perhaps I'm being a bit too optimistic considering management's recent guidance, which arrived much lower than prior expectations. On the other hand, the revision was consistent with what other chip companies have issued due to fiscal concerns here in the U.S. and abroad. Nonetheless, the company has been outperforming its peers for quite some time and is expected to continue.

For instance, over the past three years Avago's growth has arrived above the peer median. This is a group which also includes Texas Instruments ( TXN) and Skyworks Solutions ( SWKS). During that span Avago has averaged 17% revenue growth vs. the group's 7%. Likewise, Avago's earnings growth has consistently exceeded its peers by 2%.

These factors suggests the stock remains severely undervalued -- especially following its 7% slide last Friday. This has now placed Avago's price-to-earnings ratio at 13 compared to its peer median P/E which registers at 20. What's more, with the smartphone market expected to continue to grow, Avago should continue to outperform its rivals heading into 2013. Investors would be wise to load up on this stock now.

At the time of publication, the author held no position in any of the stocks mentioned.
Richard Saintvilus is a private investor with an information technology and engineering background and has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.