Intevac: Well-Run Company In A Tough Business

Intevac (IVAC) is the world’s industry leader in the disk sputtering equipment market. What this equipment does is deposit “highly engineered thin-films onto magnetic disks used in hard disk drives.” That is its main business and constitutes over 90% of its revenue.

It's also involved in the imaging business, which consists of developing products which “allow imaging or analytical detection in extreme low light situations.” The imaging group also works with the military. For its imaging department, most of its revenues have come from R&D contracts with the U.S. government. Its stock has recently fallen due to revised downward earnings guidance for the upcoming quarter.

Intevac has great growth plans. The internet and the digitalization mega trends taking place will benefit it. First, the hard drive market is projected to grow at a brisk pace due to new products that require higher storage capacity. TrendFocus projects 14.4% annual growth in hard drive shipments through 2010.

Here is a list of the major growth drivers that will benefit Intevac:

1) New consumer electronics applications are requiring bigger and bigger storage capacities for streaming video.
2) New PC growth in emerging markets in Europe and Asia.
3) Enterprises have increased needs to store data. The transformation from paper storage to digital storage is still taking place.
4) Security tapes are transforming from the historical tape standard to a new digital standard storage solution.

The imaging business is slowly growing. It also has a growth initiative to produce a manufacturing system that will work with the etch segment of semiconductors. Revenues from the etch segment manufacturing systems are not expected until 2008.

Intevac has support centers next to its major disk-sputtering equipment customers to help improve customer relationships. It also plans to build more support centers to help develop these relationships and work closer with its major customers.

Industry

This disk-sputtering equipment industry is very competitive due to the small number of customers and the high price of equipment. The customers consist of companies that operate in the hard drives industry. Those companies are large manufacturers such as Fuji Electronic (FUJI), Hitachi Global Storage Technologies and Seagate Technology (STX). It is very consolidated which could lead to price pressures in the future. Intevac’s competition consists of disk-sputtering equipment manufacturers such as Anelva Corporation, Ulvac and Oerlikon. Intevac is the industry and market share leader with a hold of 60% of the market share.

On the imaging front, Intevac competes with such military giants as ITT Industries (ITT) and Northrop Grumman (NOC) for military vision devices. For long-range vision, Intevac competes with CMC Electronics, DRS (DRS), FLIR Systems (FLIR) and Raytheon (RTN). It also competes in the commercial markets with companies such as Texas Instruments (TXN) and Roper Scientific (ROP) in the sensor and camera products market and with companies like InPhotonics and Ocean Optics in the portable Raman spectrometer market.

Both of these products have a long sales cycle, due to the high degree of customization that customers require. Revenues and earnings for Intevac are very volatile due to the small number of customers and high average price of products. Intevac also benefits from the falling dollar since its international sales for the past 3 years have been 90%, 71% and 68% of total revenues.

Valuation

IVAC is trading at a trailing price/earnings ratio of 8.53 and a forward price/earnings ratio of 12.55. The price/earnings/growth ratio is only .7. Its balance sheet is very strong with over $102 million in cash, cash equivalents, and short term investments. It has done a great job in managing its accounts receivable, improving from over 73 days average account receivable outstanding in the same quarter last year to just under 40 days average account receivable outstanding this year. In 2006 it was just over 56 days compared to almost 114 days in 2005.

Shares outstanding have been rising over the past few years; there was a big jump in 2004 due to a secondary public offering. Gross margin has been healthy, it came in at 42.9% over the past quarter, which is a record for Intevac. Operating margin has also looked good, checking in at 17.1% in the last quarter. It has consistently spent over 10% of revenue on R&D. Free cash flow was positive in 2006 for the first time since 1997. Insiders own 6.4% of the company. The current backlog is the lowest in dollar terms since the end of 2005. As of June 2nd, 2007, it was in the top 25 Magic Formula stocks with a minimum market cap of $100 million.

Technicals

The long-term trend is bullish but the short and middle term trends are bearish. It is currently trading below all three of its major moving averages. RSI is close to being at the oversold level and MACD is showing momentum to be negative although there was a recent bullish cross over. There has been an increase in volume in the recent drop which started in late February. The chart does not look very good right now; it looks like the stock will dip to at least $18 a share, which is the first strong support level. The second strong support level will be $15 a share.

Conclusion

Intevac seems to be very well run and has great technology and a great growth plan, but the industry is very cyclical and I don’t have the slightest idea at what point we are in the cycle currently. Its founder is still with the company and it has been making great advances in cutting costs such as selling, general and administrative expenses. It also stays true to its word and invests in Research and Development Expenses. One of the main issues I have with the company is its cash flow, it just had its first positive cash flow year since 1997, that does not bode well. Unless it's having a good year, its cash flows will be negative. I would stay away from Intevac due to the unpredictability of its earnings, the cyclic nature of the industry it's in, and the cash flows that it produces; the chart isn’t exactly bullish either.

Disclosure: I don’t have a position in IVAC.

Comments

[MNRTrading]

Although IVAC is considered a cyclical company, both generally and specifically in this Alex's article, it is part of an industry that from a product demand point of view is evolving into a demand driven and supply constrained commodity. That will lead eventually to a completely different valuation structure for IVAC, KOMG, STX, etc.

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