Take an in depth look at the operating results of inTest Corporation over the past three fiscal years and you will see a company that has diversified its revenues, built its balance sheet up and racked up nine consecutive quarters of profitability. The price of the stock has not responded in those three years, but maybe investors need to look again.
inTest Corporation (INTT) is a designer, manufacturer and marketer of mechanical, thermal and electrical products that are used by semiconductor manufacturers in conjunction with automatic test equipment, (ATE), in the testing of integrated circuits, (ICs). Perhaps the issue with the stock price movement is investors see the company strictly as a semiconductor equipment stock. inTest has been busy addressing this. The firm has built a diversified portfolio that includes non-semiconductor markets. This revenue should be a bit more inelastic and run on a different cyclical time frame than the semiconductor business. Non-semi revenue grew from 19% of total revenue (($9 Million)) in 2010 to 29% of total revenue (($13 Million)) in 2011. The firm's goal is to grow Non-Semi revenue to 50% of revenue. The potential for Non-Semi is enormous because it incorporates any market that uses thermal.
Non-semiconductor thermal testing remains a source of growth as well as diversification for inTest. Looking at several metrics, the stock is undervalued. According to the enterprise multiple, the P/S, and P/E, INTT appears undervalued compared to industry. (Data from Zacks.)
P/E 2012 E
P/E 2013 E
Focus on Thermal
inTest is benefiting from the increasing need for temperature testing of circuit boards and specialized components.
The firm competes mainly on two levels: wafer level and discrete product level.
Wafer level is a solid business for the firm but will never be a significant growth engine. Standards in this area are not stringent and in the past 10 years prober manufacturers have taken over. inTest serves smaller OEMs in this area with its Thermochuck product which tests semiconductor wafers at high and low ((-65 to +400 C)) temperatures at the wafer probing station.
The discrete product level is where inTest will experience growth over the next several years. These products provide the ability to characterize and stress test a variety of materials over extreme and variable temperature conditions that can occur in actual use.
The focus of is on four main areas solving unique and challenging temperature problems.
- Sensor Technology
- Fiber Optics
- Defense and Aerospace
inTest solves unique and challenging temperature problems.
Many of the thermal businesses the firm competes with are large companies that have standard products. The only model out there that has been in industrial thermal test to date is one where a customer must modify its test. inTest's business model is quite the opposite. The company asks the question "what do you have to do to test?" and builds the equipment to fit the product. This is a model that's not generally been used out there because most of the companies they compete with are very large. Being small and able to move quickly allows inTest to win these custom jobs.
New Acquisition in Thermal
In January 2012, Temptronic Corporation, a member of inTest Corporation's Thermal Solutions Group, closed on the acquisition of Thermonics, Inc. With a purchase price for the assets of approximately $3.8 million in cash (which included net working capital of approximately $1.1 million),Thermonics is expected to further enhance inTest's presence in the ATE industry as well as provide additional leverage into growth industries outside of the semiconductor industry. The integration of the acquisition is on track and management expects it to be accretive to operations beginning in the second quarter of 2012. Furthermore, management anticipates a 30 percent net contribution margin on incremental revenues which are expected to improve sequentially throughout 2012 eventually reaching as much as 35 to 36 percent over time.
Real World Solution
Real world solutions of Non-Semi applications range from problem solving in oil field environments to testing network infrastructure equipment from major telecom manufacturers. Here is a look at one.
Customer: Major manufacturer of industrial electronics
Application: Production test of pressure sensor systems for oil pipeline use.
Need: Each pressure system requires two separately controlled temperature environments. Also, specific throughput requirements.
Temp range: -100°C to +300°C
- Center zone and each outer zone are independently controlled
- 4 DUTs are mounted in apertures between the center and an outer zone
- One side of DUT is stressed at hot temperatures while other side at cold
- Simulates real-world stress this DUT sees in the field
Here is how I view the valuation of inTest:
Two Stage Free Cash Flow to Equity Model
FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment
- The firm is expected to grow at a higher growth rate in the first period.
- The growth rate will drop at the end of the first period to the stable growth rate.
Rationale for using the Model
As the non-semiconductor business ramps up to 50% of total revenues we expect the firm to grow at a higher overall rate than the industry. As These products mature and the firm faces more competition we expect the growth rate to level off.
Weakness of the Model
As you add more layers to the model it is more sensitive to the assumptions you make. The growth may look more "lumpy" than we have it in the model.
We used the following inputs:
- A 5-year period with an earnings growth rate of 8.0% and a discount rate of 13.77%.
- A continuing period assumed to go on forever, with earnings growing at 5% and a discount rate of 13.05%.
With these inputs we arrive at a target price of $7.23.
Our price target of $7.00 per share is the average of 9.2x our 2012 EPS estimate and our two stage model. We would add shares at these levels.