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Morningstar | Design Activity and Content Growth Keep NXP On Track; Maintaining $115 FVE

NXP Semiconductors highlighted the strength of its design wins in the first quarter as revenue and profitability were in line with guidance. While global conditions are uncertain, we believe management's commentary and outlook suggest an improving environment. More important, we think they support our long-term thesis on NXP; thus we will maintain our $115 fair value estimate and narrow moat rating for the semiconductor giant.

NXP’s first-quarter sales totaled $2.1 billion, above the midpoint of previous guidance. Sales by end market were largely in line with our forecast as automotive and communications infrastructure had 7% sequential declines and industrial and mobile sales declined 15% and 30%, respectively. The loss in mobile sales was predominantly seasonal, if slightly more dramatic than historically due to reduced demand for the firm’s customer interface solutions in premium products. In automotive, growth in advanced driver-assistance systems helped to mitigate the impact of a weak Chinese market and lower automotive units as sales declined 8% year over year. The industrial market was soft in the quarter as a result of the uncertain macro picture, particularly in China. That said, management described ongoing design activity in factory automation, smart home, and sound bars, which is increasing demand for the firm’s crossover chip solutions and should support sequential industrial revenue growth in the upcoming quarter.

Adjusted gross margins were strong at 52.7%, a 20-basis-point contraction sequentially and slightly above the high end of guidance. Adjusted operating margin was similarly strong and near the upper range of guidance at 26.7%. In light of the steep revenue declines, this performance was extremely encouraging and bodes well for the firm reaching target profitability goals of mid-50s and low 30s adjusted gross and operating margins, respectively.

NXP remained cautious in its guidance, highlighting that in the current environment forecasting beyond the immediate quarter was likely a fool’s errand. However, management does expect year-over-year revenue declines to slow in the second quarter and anticipates a 4% loss at the midpoint of guidance, implying $2.2 billion in revenue. Gross margins are expected to be up slightly on a sequential basis, expanding 80 basis points at the midpoint.

By end market, management’s outlook is for flat sequential revenue growth in the automotive market, mid-single-digit growth in industrials, midteens from mobile, and around 10% growth in communications infrastructure. In mobile, NXP has been seeing an increasing attach rate for its NFC solution to support payments and expects it to continue over the long-term as demand increases in the developing world. While management did not update its midterm revenue expectations for communications infrastructure (low-single-digit rate established during last year’s analyst day), it did highlight an early acceleration of demand for radio-frequency power products for 5G base stations, which would support stronger growth over the next couple of quarters. We believe management is right to be conservative on midterm guidance as these infrastructure investments will probably be very lumpy, but it remains another growth opportunity that could provide even greater upside beyond the three-year target that management has provided.

Finally, management reminded investors that in the large automotive end market (which accounts for roughly half of total sales), 70% of revenue was more closely tied to unit production but the remaining 30%, including assisted safety and radar solutions, was more inured to automotive unit fluctuations. This is a large part of our thesis on content growth in the automotive market in general, and we believe NXP’s product portfolio in ADAS, radar, digital clusters, and battery-management systems will sustain the firm’s revenue growth well above that of the end market.