We upgrade Spirent and Laird to Buy and we downgrade STMicro to Sell reflecting our views on the valuation, analog semi cycle, and competition in the MEMs business.
We believe the following are likely catalyst events in 2015 (which we detail our expectations for): Infineon-Qimonda dispute starts in court in spring 2015 and is settled, Nokia and Samsung arbitration settles (Nokia cited during ’15), Samsung sells its 3% stake in ASML (possibly to ASML) and ARM’s new CFO returns more cash to shareholders. We believe any weakness around ARM and Infineon reporting could provide a further Buying opportunity on these names.
M&A was a feature in Global and European tech in 2014 (Wolfson, CSR, AZ) and we expect ’15 to be similar with possible areas of focus being mapping/telematics, test & measurement and optical networking. While we expect wireless equipment to consolidate further, this is more likely a 2016 event, with potential upside for Alcatel- Lucent to €3.6-5.8/share if it occurs. Tech-wise we expect more in ’15 from 64-bit processors, small cells, LTE broadcast, VoLTE, G.Fast, EUV and FD-SOI.
The European hardware sector trades on 19.4x ‘15E P/E and EV/EBITDA of 11x vs its historic range of 12x-23x (avg 18x) and 5x-11x (avg 8x) respectively. We have a quality bias going into 2015 with ARM, Infineon and ams particularly fitting this bill. We would see any analog weakness as a further opportunity to invest in Infineon and maintain our Buy on Monitise.
Our key conclusions are:
– Upgrade Spirent and Laird to Buy. As we roll-forward our DCF based price targets and following relative under-performance recently we upgrade Laird and Spirent. In addition to other drivers (discussed later) both should, like ARM, be beneficiaries of the weaker GBP into 2015. We sit above consensus operating profit for FY15 for both Laird and Spirent (11% and 6%).
– Downgrade STMicro to Sell. Following a recovery in the shares recently, we downgrade STMicro to Sell from Neutral. While the company has some positive drivers in 2015, we believe the valuation is full and risks remain around MEMs competition (UBS sits 14% below consensus EBIT FY15).
– General preference for “quality”. The quality stocks continued to outperform in 2014 led by Nokia and ASML. In 2015 we maintain our positive bias for quality in 2015 but look to companies such as ARM and ams. How do we define quality? In the report we use a quantitative framework using metrics such as industry concentration, management alignment with shareholders and R&D efficiency to rank our coverage universe. Unsurprisingly ARM is, based on these, the highest quality company in the sector.
-M&A is likely to be a prominent feature again in 2015. Cash continues to accumulate in Global Tech with gross cash likely to surpass US$1 trillion in ’15. We expect M&A therefore to continue to be a feature in 2015. We provide a quantitative screen based on a variety of factors (size, valuation, free-float etc.) and on this basis several European companies feature as potential consolidation candidates, including Spirent and Laird. While we do not believe it to be imminent, potential consolidation in wireless equipment could see upside to €3.6-5.8/share (average €4.7) at Alcatel-Lucent.
– Upside surprises possible in cash returns. In addition to M&A, we have attempted to assess which of the European companies could return more cash to stakeholders than expected. We highlight ARM, ASML and Nokia.
-By sub-sector, in 2015 we see another robust year for semi capex (+12% after +16% in ’14), softer telecom capex (-6% ’15E) but stable vendor revenue in constant currency terms (+3% in ’15E), ongoing strong growth in low end smart-phones (total smart-phone units +20% in ’15E) which should benefit ARM, a medium-term inventory correction in analog semis (with solid underlying trends), and the continuing emergence of mobile payments.
– The sector is trading on 19x ’15E P/E, almost exactly where it was a year ago (18.5x ’14E) and continues to trade above its average price/book (3x vs 2.5x) reflecting the rerating seen at ASML and Nokia.
– Stock-wise, of the larger names we would recommend Alcatel-Lucent, ams, ARM, and Infineon which all have strong positive company specific drivers for 2015 or beyond.