Why Skyworks Solutions Could Become the Next Big Internet of Things Play

The Internet of Things (IoT) space saw terrific growth in 2017. Gartner estimates that 8.4 billion things connected to the internet last year to boost the installed base of IoT devices by 31% year-over-year. But this market hasn't hit critical mass just yet -- the number of connected objects is expected to hit 130 billion by 2030, according to IHS Markit.

So, it is still early days in the IoT market as it hasn't realized even 10% of its long-term potential, and investors looking for ways to profit from this revolution can win big in the long run if they make the right choices now. Of course, there are big names such as Cisco, which is pioneering this field with its networking expertise. But investors looking for a small-cap play whose financials could be materially impacted by IoT need to take a closer look at Skyworks Solutions (NASDAQ: SWKS). Here's why.

IoT is becoming a substantial part of the business

IoT is currently a small part of Skyworks' overall business as it makes most of its money by supplying chips to smartphone companies, notably Apple. In fact, Cupertino supplied 39% of Skyworks' total revenue in fiscal 2017, but the chipmaker has been aggressively trying to dial down its reliance on the iPhone maker and the smartphone market in general.

Skyworks' non-mobile business now accounts for one-fourth of its overall business, supplying $263 million in revenue last quarter. This segment has been growing at a solid pace by supplying chips for IoT verticals such as connected vehicles and connected homes, having recorded annual growth of 16% over the past three years. This has helped the chipmaker reduce its reliance on Apple (which that accounted for 44% of the top line back in 2015). More importantly, Skyworks' management is confident of at least sustaining this growth longer term. CEO Liam Griffin recently said that he sees a "steady path to mid-teens" for the broad markets segment going forward.

Skyworks has been busy building its IoT-related client base, which is evident from the growth in its broad markets revenue. For instance, the company was supplying $20 worth of chip content to connected cars back in 2014 when this space was in its early phases of growth.

Seeing a massive growth opportunity, Skyworks has spent years building up its expertise in connected cars. In 2014, annual sales of connected cars were around 10 million units, according to Skyworks' estimates, while total car sales stood at 60 million. Looking ahead, it is estimated that all the cars sold by 2025 will be connected to the internet, and Skyworks doesn't want to miss this gravy train. The good news: the chipmaker has already struck a few deals in the automotive space that will boost its prospects in the long run.

For instance, Hyundai has begun volume production of in-vehicle telematics systems using Skyworks' chip. Meanwhile, Chinese company ZTE is using Skyworks' chip platform to power its connected car solutions.

Skyworks has cut its teeth in the fast-growing smart-home market as well. In fact, the company's chips are being used by the likes of Amazon, Google, GE, Netgear, and others to power their wireless home solutions. Now, Cisco forecasts that smart homes will account for half of IoT connections by 2020, so this is another big opportunity for Skyworks given its early design wins over here.

So, it won't be surprising if Skyworks' broad markets business exceeds its growth target. But even if it grows in line with management's mid-teens forecast for the next five years, it could double in size and contribute over $2 billion in annual revenue as compared to the current annual run rate of just over $1 billion.

The IoT shift makes it a compelling long-term bet

The growing clout of Skyworks' IoT business makes it a solid bet for investors looking to cash in on this trend. But they need to remember that Skyworks is still a smartphone chip supplier primarily, with mobile constituting 75% of the revenue.

The good part is that Skyworks has been working to reduce its reliance on smartphones and it has found success on this front, as evident from the growth of the IoT segment. What's more, the company has managed to overcome the price wars in the smartphone chip space and improved its margins.

SWKS Operating Margin (TTM) data by YCharts

I believe that the IoT business has had a role to play in Skyworks' margin gains, as the addition of this line of revenue over the past three years has coincided with the rise in its margins. So, there is a strong possibility that the company's earnings will improve as IoT revenue grows over time.

Until then, Skyworks will reward investors with its dividend yield of 1.31%, which could be raised further thanks to solid free cash flow generation and a pristine balance sheet. And finally, Skyworks' low forward earnings ratio of just 13, as compared to the industry average of 34, means that investors are getting this emerging IoT play on the cheap.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Skyworks Solutions. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.