Is ARM Holdings plc Set For Electrifying Earnings Growth In 2014?

Today I am looking at microchip builder ARM Holdings’ (LSE: ARM) (NASDAQ: ARMH.US) earnings prospects for 2014.

An expensive pick despite heady earnings outlook

Swelling demand for smartphones and tablet PCs has thrust earnings, and consequently ARM Holdings’ share price, towards the stars in recent years. Even taking into account May’s eye-watering price dip, the stock still gained 43% during the course of 2013 alone.

Market research specialists International Data Corporation (IDC) expect this trend to continue, and reported last month that “despite a number of mature markets nearing smartphone saturation, the demand for low-cost computing in emerging markets continues to drive the smartphone market forward.” They expect global smartphone shipments to pass 1bn units for the first time in 2013, before moving towards 1.7bn by 2017.

Critically for ARM, however, the body also highlighted the accelerating switch towards low-cost devices by consumers — IDC expects an average price of $337 per unit this year, down from $387 in 2012 and which is expected to drop gradually through to 2017 when a price of $265 is predicted.

Of course, this phenomenon will weigh heavily on component builders for the world’s major phone manufacturers, a trend clearly evident out in ARM’s October trading statement. This showed royalties remain static at 4.9 cents per chip during July-September, and as device prices come down this problem is likely to worsen.

Optimists will point to the firm’s entry into new markets and technical innovations as helping to deliver a record 48 licence agreements during the period. But one should not underestimate the rising presence of heavyweight rivals, particularly within ARM’s revenues-driving phone and tablet markets. Most worryingly, Intel continues to ink alliances with long-standing ARM customers such as Samsung, and its plans to turbocharge its chip portfolio over the next 24 months could harm the British company’s earnings outlook.

ARMs’ explosive growth in recent years results in a compound annual growth rate of 27.4% since 2008, and City analysts expect the firm to punch further substantial earnings expansion in the near future. Indeed, the chip builder is anticipated to follow expected earnings of 20.6p per share for 2013, a 38% on-year rise, with an additional 21% increase in 2014 to 25p.

Still, in my opinion these gargantuan growth rates are already factored into the share price, as ARM currently changes hands on a P/E multiple of 43.8 for 2014, a stratospheric reading compared with a forward average of 24.1 for the complete technology hardware and equipment sector.

Although adoption rates of tablet PCs and smartphones is starting to plateau, the market remains ripe for those at the technological coalface in these markets for at least the next few years. But for ARM, in my opinion the threat of accelerating competition in these markets and lower royalty revenues makes it hard to justify the firm’s premium share price rating. And like other entities that carry elevated earnings multiples, I believe that ARM is in danger of a weighty price collapse.

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> Royston does not own shares in any of the companies mentioned in this article.