Is InvenSense Inc. Stock a Buy?

By Markets Fool.com

After InvenSense reported its third-quarter earnings at the end of January, I noted that the sell-off presented a good buying opportunity. Now that shares have recovered from the sell-off, some investors may be wondering if it's too late to get in. Let's take a look at what we can expect from InvenSense going forward, and whether shares are still a buy at their current price.

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iPhone revenue will drive more growth
In light of its design win with Apple , InvenSense saw excellent revenue growth in each of the last two quarters. In fiscal 2016 (which starts in March), InvenSense will have at least one quarter of easy comparables, where it didn't have the Apple contract.

InvenSense chips are only in the new iPhone models. Source: Apple

What's more, InvenSense will also benefit from moving to a 100% share of Apple's iPhone designs. (Apple still sells some units of the older models -- the iPhone 5 and iPhone 5s -- that don't have InvenSense chips.)

Historically, the newer model iPhone accounts for around half of total iPhone sales in quarters following the first full quarter after launch. With the draw of the larger screens of the iPhone 6 and iPhone 6 Plus, the new models may account for closer to 60% of iPhone sales over the next three quarters. Last quarter, the new models accounted for 75% of iPhone sales.

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Apple accounted for 45% of InvenSense's revenue, or $52 million, in the company's third quarter. If we assume InvenSense increases its share to 100% of iPhones next year from 75%, revenue from Apple will grow to almost $70 million in the same quarter next year.

And that assumes no unit growth from Apple. The revenue growth will likely be even more pronounced in the following quarter due to the historically lower portion of iPhone sales going to the new model -- closer to 66% growth.

More content means more revenue
With non-Apple customers, increasing the amount of content InvenSense provides in a smartphone will be key to growing revenue. On the company's third-quarter earnings call, CEO Behrooz Abdi told investors that he thinks InvenSense's content opportunity will double in fiscal 2016.

Xiaomi's Mi4 likely contains InvenSense's 6-axis sensor and software running on a discrete sensor hub. Source: Xiaomi

Increasing the amount of content in each smartphone -- especially software content that InvenSense has invested in -- will not only increase revenue, but gross margin as well. What's more, it makes those customers stickier because they become more reliant on InvenSense's software and interoperability between chips. The switching costs increase.

Abdi says it has a "leading OEM that's already shipped with our software running on a separate and discrete sensor hub." It sounds like either Xiaomi or LG, both of which accounted for significant amounts of revenue before Apple started dominating the top line.

Additional contracts like the one with a "leading OEM" will help counterbalance the gross margin pressure from Apple -- which doesn't have much potential for software content sales.

So, is it a buy?
Analysts are currently projecting revenue growth of less than 20% for fiscal 2016. That seems rather low considering the likelihood that revenue from Apple will keep increasing substantially in 2016. Note that increased iPhone sales may be offset by decreased Samsung sales now that InvenSense has nearly saturated the Korean OEM. However, growth in wearables from both companies could boost unit shipments.

Continued growth at its smaller customers like Xiaomi, Huawei, and LG, through increased smartphone sales and increased content per smartphone, should help grow revenue much more than the 20% benchmark laid out by analysts.

Analysts do expect profit margin to expand next year from an estimated 11.5% this year to about 14.2% next year. That, too, however, may be somewhat conservative considering plans to level off R&D spending and the impending revenue growth.

As a result, I think there's a strong chance that InvenSense beats analyst expectations in fiscal 2016 on both the top and bottom lines. There are some risks involved with the investment, but overall I think InvenSense justifies its relatively high valuation (23.5 times analysts' 2016 earnings estimate) due to the strong growth potential over the next year or two.

I would still buy InvenSense at its current price, around $16 per share.

The article Is InvenSense Inc. Stock a Buy? originally appeared on Fool.com.

Adam Levy owns shares of Apple and InvenSense. The Motley Fool recommends Apple and InvenSense. The Motley Fool owns shares of Apple and InvenSense. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.