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Today, most electronic products contain a combination of integrated circuits (ICs). As technology continues to penetrate most aspects of daily life, semiconductor devices are playing a more important role in a growing number and variety of products. Consequently, the global semiconductor industry, while experiencing significant cyclical fluctuations in its growth rate, has exhibited strong overall growth over the past 30 years.

The design and manufacture of semiconductor devices is a complex and capital-intensive multi-step process. The process involves different types of equipment used to manufacture, assemble and test semiconductor devices. Semiconductor test equipment and services are a critical part of this complex design and manufacturing process and are utilized in each of the key design and manufacturing stages. Each of these ICs has electrical circuitry that requires validation or testing during and after the manufacturing process. The final usability of the IC is determined by testing.

Three primary factors ultimately drive demand for semiconductor test equipment:

  • Increases in unit production of semiconductor devices;
  • Increases in the complexity and performance level of devices used in electronic products; and
  • The emergence of next generation device technologies.

The increases in unit production result primarily from the proliferation of the personal computer, growth of the telecommunications industry, consumer electronics, the mobile internet, broadband network access, the increased use of digital signal processing (DSP) devices, and automotive and power management applications. These increases in unit production, in turn, lead to a corresponding increase in the need for test equipment.

Furthermore, demand is increasing worldwide for smaller, more highly integrated electronic products. This has led to ever higher performance and more complex semiconductor devices, which, in turn, results in a corresponding increase in the demand for equally sophisticated test equipment.

There has been considerable consolidation of the semiconductor test companies during recent years. Teradyne (NYSE:TER) acquired both NexTest Systems and Eagle Test Systems, and LTX Corporation merged with Credence Systems to form LTX-Credence Corporation (LTXC). Other players in this segment include Verigy (NASDAQ:VRGY) based in Singapore, and Advantest (NYSE:ATE) from Japan.

Notwithstanding the consolidation, the market for semiconductor test systems is highly competitive, rapidly evolving and subject to changing technology, customer needs and new product introductions. Moreover, the economic downturn that began in late 2008 and has continued through 2009 and 2010 has dramatically reduced the level of investment in semiconductor test equipment and has rendered the competition for the reduced level of business more intense.

For the purposes of this article, we provide several data points for the companies mentioned above:

Ticker

Company

Recent Price

Price Chg. 52W

CFROI

EV/ EBITDA

ROE 12M

Price to 52W Range

ATE

Advantest Corp. (ADR)

21.25

-10.00

-1.93

35.51

3.20

34.88

LTXC

LTX-Credence Corporation

9.30

37.00

29.83

7.03

25.60

67.92

TER

Teradyne, Inc.

17.79

96.00

33.92

6.49

39.70

96.44

VRGY

Verigy Ltd.

13.76

28.00

3.88

25.45

3.90

99.52

In our analysis of a company, we place an emphasis on identifying companies that are undervalued, profitable and generate free cash flow. Both LTXC and TER generate strong free cash flows as measured by the metric free cash flow to invested capital. Both companies appear to be undervalued on the basis of EV/EBITDA and both are profitable based on ROE. ATE and VRGY are less impressive when compared to either LTXC or TER.

Year-Over-Year sales growth has been very strong for all companies. The five year sales growth rate for ATE is negative and for VRGY a slow 3.4%. Both LTXC and TER grew sales at a sustainable rates; 10.3% and 9.0%, respectively.

Net income grew dramatically for all companies on a Y-o-Y basis. Again, net income growth varied widely for these companies over the past five years. ATE experienced negative net income growth. LTXC and VRGY had five year growth rates of about 16%. TER had the best growth rate of 33.2%.

All four companies have reasonable balance sheets with either no or manageable debt. ATE pays a dividend of $0.12 per share producing a yield of 0.5%.

MarketGrader rates ATE a sell, LTXC a buy, TER a buy, and VRGY a hold.

Semiconductor test equipment companies are in a growth but cyclical industry. The near term may be shaky but looking out to when the economy is more fully recovered, these companies stand to do well.

Source: Semiconductor Test Equipment Stocks Should Do Well When the Economy Recovers