Can ARM return 35% in 12 months?

It’s been six months of impressive growth at chip-designer ARM Holdings and management seem to have been laying the foundations for more to come. The company, which supplies the chips for Apple products, is trading on an undeserved discount in Goldman Sachs' eyes.

Overall, first-quarter performance was good. Sales jumped 22% to £227.5 million, made up mostly from royalty revenue, and pre-tax profit grew by a quarter to £120.5 million, giving earnings per share (EPS) a nice boost to 7.1p. Net cash swelled to £68.5 million, a good thing for dividends. Operating expenses mirrored the rise in sales, increasing 20% to £100 million, and margin rose to 51.7% from 50.4% last year.

Bullish on ARM's future royalty growth, Goldman analysts are waiting for news on the use of its V8 product in smartphones, namely the Samsung Galaxy S6, greater market share gains in microcontrollers and the adoption of its technology in networking and servers.

Says Goldman:

ARM currently trades on a 2016E P/E of 28.4x, below the 5-year trailing average of 29.5x (current PEG is 1.1x vs. a 5-year average of 1.2x). We view these discounts as unwarranted given our estimate of a 24% EPS CAGR [compound annual growth rate] (2015-19), doubling CROCI [cash return on capital invested] by 2018 given margin leverage, and potential for higher cash returns. Our 12-month price target remains 1550p based on our royalty DCF [discounted cash flow], and we remain CL [conviction list] Buy given first quartile upside vs. EU Tech.

Of course, there are risks here, namely from fierce competition, slowing innovation at the group and market share limits.

But Goldman has pencilled in EPS growth of 36% in 2015, 26% in 2016 and 23% in 2017, to be supported by tasty dividend increases. In 2015, dividends are tipped to jump 40%, by 36% in 2016 and 23% in 2017.

The analysts reckon ARM could be worth 1,550p this time next year, a potential return of 35% and nearly double October's low (see chart).

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