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)).
In my last article I argued inTest has been busy building a business model not solely associated with the semiconductor test market. 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.
The company will host a conference call on Wednesday, May 2, 2012 at 5:00 p.m. Eastern Time. Here is what investors should look for.
- How has the new acquisition been added in to the business?
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. 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.
This is a better question than simply looking at the percentage of non-semi revenues and bookings since the combination of a large order and weakness in Mechanical and Electrical product segments made the non-semi revenue and bookings appear stronger. Recall the company competes against firms that make standard products, while inTest builds the equipment to fit the product. Being small and able to move quickly should allow inTest to win these custom jobs.
This may be an area for investors to watch for the rest of the year rather than in one quarter.
- What is the overall health of the semiconductor market?
Non-semi revenue grew from 19% of total revenue ($9 Million) in 2010 to 29% of total revenue ($13 Million) in 2011. Even with significant inroads into diversification of the business model, inTest still derives approximately 70% of revenues from semiconductor. All signs here point to a rebound. More chips mean more testing for inTest.
The Semiconductor Industry Association (SIA) announced that worldwide semiconductor sales for 2011 reached a record $299.5 billion, a year-on-year increase of 0.4 percent from the $298.3 billion recorded in 2010. 2011 was a particularly volatile year with natural disasters in Japan and Thailand.
The SIA had this to say in its latest monthly sales report,
"With a continued macroeconomic recovery, semiconductor sales are expected to improve this year in part due to positive demand drivers across a range of end markets. As products with improved functionality in mobility, sensing and energy efficiency come to market to meet consumer and enterprise demand, semiconductor sales are expected to continue along the path of long term growth."
For semiconductor capital equipment spending, expectations are a bit more mixed. Gartner expects worldwide semiconductor capital equipment spending to total $35.2 billion in 2012, a 19.2 percent decline from projected 2011 spending of $43.5 billion. Excess electronics inventory and poor demand as a result of the slowing macro economy are to blame for the declining spending. By mid-2012 Gartner expects the supply and demand to be more in balance, so DRAM and foundry will need to begin to increase spending to meet an increase in demand as the PC market rebounds and consumers begin spending once the economy stabilizes a bit. The next growth year is expected to be 2013, when capital spending will increase by 18.4 percent.
inTest benefits from both capacity increases and technology advancement.
- Watch for Docking versus Manipulators. What does this tell us?
On the fourth quarter of 2011 conference call CEO Robert Matthiessen had a clear and concise explanation of Docking versus Manipulator.
The Docking Hardware business diverges from the Manipulator business in that when the industry is down docking is normally fairly strong because customers will take existing equipment and try to mix and match to get more throughput between testers and various probers and handlers. Docking Hardware typically tends to go on even in poor times. When manipulators are selling like this past quarter, you also get docking hardware along with that, the firm usually sells a set with each manipulator, and so, you get hits on both ends with the docking hardware business.
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.
P/E 2012 (E)
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.