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1 Big Reason to Buy Analog Devices

Sales of electric vehicles (EVs) are expected to take off remarkably in the future. Last year, EV sales crossed the 2 million mark, accounting for just a fraction of the 88.1 million units in global auto sales. But Bloomberg New Energy Finance forecasts that EVs will supply 54% of new car sales by 2040 thanks to plunging battery prices.

Analog Devices (NASDAQ: ADI) is one of the best ways to ride this rapid growth as its battery management products are critical to the functioning of EVs. More specifically, these battery management systems (BMS) are the brains of the battery pack used by EVs, managing several functions such as charging, discharging, and protecting the individual batteries from getting damaged.

The spurt in EV sales will drive BMS sales at a fast clip, with one estimate suggesting an annual growth rate of over 20%. Therefore, Analog Devices has set its sights on making the most of this fast-growing opportunity through product development moves and a crucial acquisition, which could substantially boost its revenue in the long run. Let's see how.

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Analog is setting itself up to strike it big in BMS

Analog Devices has pulled in just under $4.6 billion in revenue over the past year and a strong foothold in the BMS space could be a big long-term catalyst for the company. So the company is going all out to carve a bigger share of this market for itself on the back of its BMS platform that's geared to deliver several incentives to EV makers.

Analog Devices claims that its BMS solution can increase the driving range of EVs by over 25 miles, delivering over $500 in cost savings to the car maker. The company also advertises that the system can extend the battery life of EVs by more than 10 years. But Analog isn't done yet pushing the envelope as its next-generation solution will help it deliver a wireless BMS platform to EV makers.

As a result, the chipmaker's solution will become more reliable by eliminating the safety hazards related to wires and connectors. It will also reduce the weight of the BMS, helping EV makers deliver a longer range to consumers. This should extend Analog Devices' first-mover advantage in the BMS market when compared to rivals such as Maxim Integrated or TE Connectivity.

More specifically, Analog's BMS product is already in its fourth generation, and it should keep getting better after the acquisition of Linear Technology that was closed earlier this year. The acquisition has significantly improved Analog's standing in the automotive space, boosting the segment's revenue 69% year over year during the third quarter.

This, however, is just the beginning as Linear's power management products will complement Analog's existing line-up by delivering increased power density and reduced emissions. More importantly, the Linear Technology acquisition has given Analog's automotive business more weight as both companies had combined revenue of $900 million from this segment last year.

But it won't be long before the automotive business gets even better as Analog expects its chip content in EVs to double going forward. This could increase the company's addressable market in electric vehicles to $3 billion in the next five years as stronger chip placement will be complemented by a surge in sales. By comparison, the company's end-market opportunity in the EV space currently stands at $1.5 billion.

Therefore, Analog can win big from the EV space provided its execution remains strong, which will eventually lead to a stronger earnings performance.

Check out the forward valuation

Analog Devices is definitely not cheap given its price-to-earnings (P/E) ratio of almost 43. This is significantly higher than the industry average of almost 25. But investors shouldn't forget that the massive opportunity present in areas such as BMS, factory automation, and consumer electronics could lead to annual earnings growth of, according to analyst estimates, more than 18% over the next five years, higher than the 16% annual growth it has delivered in the last half-decade.

Considering this potential earnings growth, it isn't surprising to see why Analog's forward P/E ratio is less than 18, which makes the stock an enticing bet going forward.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.