This Dividend-Paying Chip Stock Could Switch Up a Gear in 2020

Secular end-market growth should be a catalyst for chipmaker Analog Devices in the new year.

Analog Devices (NASDAQ:ADI) has been hit hard by the semiconductor slowdown this year. The company's revenue in the recently concluded fiscal year 2019 fell nearly 3.7% over the prior year, driven by the restrictions on Huawei and the broader slowdown in key chip markets such as the industrial and automotive sectors.

However, investors have been buying Analog Devices stock despite the headwinds. The stock has generated a decent return even in tough times, paving the way for more upside in 2020, when things are expected to get better. Let's take a look at the reasons you should consider going long on Analog Devices right now.

Recovery is in the cards

Analog Devices' fiscal 2019 fourth-quarter results revealed that its industrial business has started turning around. The company's industrial revenue increased slightly year over year to $744 million, accounting for 52% of the overall top line.

Analog credits the slight improvement in its industrial revenue to "strength in aerospace and defense, healthcare and electronic test and measurement" markets. More importantly, the company anticipates that the industrial business will get better from the second quarter of fiscal 2020 once the inventory correction is over in the first quarter.

Responding to an analyst query over the earnings conference call, Analog Devices CFO Prashanth Mahendra-Rajah said that he estimates a sequential increase of 5% to 10% in industrial revenue during Q2. The recovery Analog anticipates starts making sense if we consider that the overall semiconductor market is expected to bounce back strongly in 2020.

According to IHS Markit, worldwide semiconductor market revenue is expected to increase by 5.9% next year following a drop of 12.8% in 2019. The aerospace and defense sector, for instance, is expected to stage a comeback next year. Deloitte anticipates a 3% to 4% increase in defense spending in 2020, while demand for commercial aircraft is also expected to pick up the pace.

An industrial recovery, however, is not the only catalyst for Analog Devices next year. The company's communications business saw strong momentum last year, enjoying 12% annual revenue growth thanks to the deployment of 5G (fifth-generation) wireless networks.

Though the communications business did take a hit in the final quarter of fiscal 2019, Analog believes that it will be back on track next year, since 5G rollouts are still in their early phase. According to CFO Mahendra-Rajah, "We are at the early stages of the Global 5G rollout, and we remain confident in our expectation that our comm's revenue will grow in 2020 and beyond, given our market-leading position and higher content opportunity in 5G."

All of these tailwinds have expanded Analog's opportunity pipeline to the tune of 15% for next year, according to CEO Vincent Roche. So there's a good chance of Analog Devices making a nice comeback in 2020 on the back of the secular growth opportunities in the industrial and communications markets.

An attractive dividend is a cherry on the cake

Analog Devices has delivered a decent stock price upside this year. But at the same time, the company also pays a nice dividend. Its dividend yield of 1.90% is better than the 1.5% average dividend yield of tech companies in the S&P 500. More importantly, Analog Devices has raised its dividend 16 times in the last 15 years.

This makes it an ideal choice for investors looking for a combination of growth and dividend in a single stock, especially considering the potential turnaround that could happen in 2020.

Analog Devices follows a philosophy of returning 100% of its free cash flow to investors through dividends and buybacks after debt repayments. The company returned 120% of its free cash flow by this method in the last fiscal year after repaying $850 million of its debt.

Analog's free cash flow generation took a slight hit last year as its top and bottom lines declined, but better days in 2020 could take care of that and help the company bump the dividend once again.

In all, Analog Devices can give investors the best of both worlds. Its growth could go up a notch as the catalysts listed above come into play and lead to stock price upside, while the dividend will provide investors with a regular income stream.