Orbotech: Well Positioned for Flat Panel Growth

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Includes: GLW, JBL, ORBK
by: Tom Armistead

Orbotech Ltd. (NASDAQ:ORBK) disclosed Thursday at the annual Needham & Company Growth Conference that its goal is to double the number of direct imaging units it installs in 2010 as compared to 2009. While the direct imaging units are not their largest product line, this is one of a number of recent encouraging signs for ORBK.

The company manufactures equipment used in the manufacturing process for FPD (flat panel displays) and is well positioned to participate profitably as the industry moves up to the next level. Shares closed Thursday at 9.03. Shlomi Cohen follows Israeli tech and has written about the company several times, making a bullish case. The most recent presentation (from the company's website) is useful.

Corning (NYSE:GLW), after reporting a strong Q3, said worldwide sales of LCD TVs and notebook computers in 2010 each could jump nearly 20%, which might result in a 15% jump in the worldwide glass market. Corning is well-situated to provide insight into the progress of the FPD industry, and its outlook suggests a favorable environment for ORBK

From the company's 20-F:

Orbotech is principally engaged in the design, development, manufacture, marketing and service of yield-enhancing and production solutions for specialized applications in the supply chain of the electronics industry.

The Company’s products include automated optical inspection (“AOI”), production and process control systems for printed circuit boards (“PCB”s) and AOI, test and repair systems for flat panel displays (“FPD”s). The Company also markets computer-aided manufacturing and engineering (“CAM”) solutions for PCB production.

In addition, through Orbograph Ltd. (“Orbograph”), the Company develops and markets character recognition solutions to banks and other financial institutions, and has developed a proprietary technology for web-based, location-independent data entry for check processing and forms processing...

Normalized or recovery earnings: The focus of this essay is to discuss possible target prices, a task made somewhat more difficult by recent write-downs, the 2008 acquisition of Photon Dynamics, and uncertainties about the strength of the global economic recovery. One way of dealing with the case is to envision the situation that will prevail if and when the company has digested its acquisition, completed its restructuring and resumed profitable growth.

The 2008 20-F has pro forma information on the combination of ORBK and Photon Dynamics for 2007 and 2008. Revenues were $430 million and $568 million, respectively. Averaging the two suggests possible sales of $499 million. Looking past the 3rd and 4th quarters of 2008, which included large write-downs of goodwill, research in progress (an acquisition item) and other intangibles, ORBK over the years has been able to achieve an average net income of 7.6% as a percentage of revenue. Being conservative, $450 million X 7.6% = $34.2 million net income, divide by 34.1 million shares outstanding is $1 X 23 = 23, a reasonable target figure.

Flat panel growth is expected to advance by low double digits for the next 3 or 4 years. If ORBK participates, a P/E of 23 is likely for a strong growth situation.

Price to Sales ratios: Where earnings are uneven or cyclical or influenced by non-cash write-downs, price to sales is often more informative than P/E. Again using $450 million as a recovery target, estimated sales divide by 34.1 million shares = 13 sales per share. The company's historical midpoint on the P/S ratio is 1.6, suggesting a target of 21. Industry ratios are dependent on where you classify the company: I see Scientific and Technical Instruments. Ameritrade, using data provided by Reuters, says the industry P/S is 2.96. ORBK has traded at a P/S ratio over 2 during several of the past 5 years, so that is not out of reach.

Ken Fisher has suggested buying small tech growth stocks at P/S ratios of .75 to 1.5 and selling at 3.0 to 6.0. ORBK, at TTM P/S of .77, is at a good starting point under this theory.

Does P/S work? This situation is similar to Jabil Circuit (NYSE:JBL) when I wrote it up favorably in April 2009. At the time, JBL had just taken massive write-downs on goodwill, citing market prices. With the stock trading in the 6 area, up from as low as 2.90, I somewhat dubiously applied the P/S line of thinking and confessed embarrassment while suggesting a target range on that basis of 17 to as high as 27. With the stock now trading in the 17 area, that doesn't seem so far fetched today.

Target: Assuming global economic recovery, FPD growth and Orbotech's participation, my target price is 21 within two years.

Disclosure: Long ORBK, no position GLW, JBL