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Morningstar | Marvell's Solid Quarter Tempered by Expected Storage Weakness; Maintaining $21 FVE

Marvell Technologies reported a solid third quarter that was reasonably expected, based on the firm’s analyst day midway through the period. This was the first full quarter with Cavium fully integrated into the business, and the firm grew both storage and networking while also expanding adjusted gross margins. However, the firm’s expected storage controller decline is mirroring the pause seen in the broader market with management guiding for declines across storage technologies for the next few quarters. That said, we believe this is temporary as the storage requirements for cloud and enterprise customers are not abating. We also believe the firm’s potential for growth remains healthy, with 5G revenue becoming potentially additive in late fiscal 2020 while interest in the nascent ARM compute chips increases. In sum, we are leaving our fair value estimate unchanged at $21 a share. The stock rebounded in aftermarket trading, but we still view shares as significantly undervalued. While we reiterate our no-moat rating for Marvell, we do believe it will have plenty of growth potential in the years to come.

Revenue in the third quarter was $851 million, a 28% sequential increase with a full period of Cavium revenue. Storage sales increased by 29% versus the prior-year period to $407 million with the addition of Cavium’s fiber channel business adding $80 million in quarterly revenue by our estimates. Networking revenue in the quarter grew 57% to $398 million for the quarter, ahead of management’s expectations, driven partially by the improved high-end product mix from Cavium’s embedded chip business. Marvell’s switch and PHY business performed well, growing 30% year over year. Finally, while not yet contributing significantly to revenue, management reported 5G design activity increasing across several business tiers and products. Adjusted gross margins improved to 64.6%, primarily due to the superior margin mix with the addition of Cavium.

Management expects revenue in the fourth quarter to decline sequentially by 5% to $810 million at the midpoint. Storage is expected to record double-digit sequential declines in the fourth quarter as data center and enterprise clients work through their existing inventory after several quarters of strong demand. The severity of this drawdown is similar to that of Marvell’s largest customers (Seagate and Western Digital) but as with those companies, we believe the pause will be followed by significant growth in demand for SSD and high capacity HDD controllers from cloud customers. Marvell has positioned its portfolio well to benefit from the demands for both, in our view. Despite the negative impact of the weakness in the storage market, management expects incremental margin expansion in the upcoming quarter with adjusted gross margins topping 65% in the fourth quarter. Adjusted earnings per share are expected to dip by 3% sequentially to $0.32 at the midpoint.