Semiconductor test equipment typically follows a different pattern than other types of semiconductor equipment, but the market was in a “shoot first, ask questions later” mood on Teradyne (NASDAQ:TER) going into the fourth quarter, concerned about an overall decline in the semiconductor sector and perhaps some company-specific risk tied to Apple (AAPL). On top of all that, I believe there were growing concerns that the weakness in China and auto customers expressed by Yaskawa (OTCPK:YASKY) and Fanuc (OTCPK:FANUY) would spill over into Teradyne’s fast-growing cobot-driven Industrial Automation segment.
All things considered, business is holding up a little better than feared. The first half of 2019 is going to be challenging, and the cobot business likely isn’t going to grow as fast, but investors were prepared for worse. With revenue growth potential in the mid-to-high single-digits and FCF growth potential in the high single digits, I believe these shares are undervalued, but market expectations of improving conditions for semiconductors and semiconductor equipment could still leave some perception risk, not to mention the risk of further deterioration in China and auto end-markets.
Better-Than-Expected Numbers To Close The Year
Teradyne reported better than 8% revenue growth to finish the year, beating expectations (which had been coming down with guide-downs from chip and chip equipment companies) by 5%. Semi test revenue rose 8%, wireless test revenue rose 43% (a solid beat for a small business), and systems test revenue dropped 55%, but also beat expectations. Industrial Automation revenue jumped 55% from the year-ago period, beating expectations by 9% with 28% growth in the Universal Robots business.
With an improved mix, gross margin improved nearly three points, helping propel 21% operating income growth and close to three points of operating margin improvement. With the Street expecting flat gross margin and an operating margin decline, this was a strong beat at the operating line.
Guidance was mixed. The midpoint of management’s range ($475M) suggests a small year-over-year decline in the first quarter, and the midpoint was a couple percentage points below the prior average estimate. Still, I think investors were braced for worse, and I think that’s a relative win. Likewise with the guide-down on EPS – a nearly 10% reduction in guidance is objectively not good, but I think there were a lot of concerns out there that it would be worse.
Within that guidance, I still see some relatively encouraging details. Management suggested that Teradyne will outperform the semi test market in 2019 by about 10% (which, given the almost-duopoly nature of the market, basically means Advantest (OTCPK:ATEYY) ) due to opportunities from increasing design complexity, a new memory product (DRAM Magnum), and some earlier-than-expected 5G – a market that appears to be ramping in earnest based on commentary from both Xilinx (XLNX) and Texas Instruments (TXN).
The Cobot Opportunity Still Matters
Investors may have been less pleased with what Teradyne management had to say about the robotics business, as the company acknowledged slowing demand and rising headwinds in China in general (a strong initial market for Teradyne’s cobots) and the auto end-market in particular in both China and Europe. Here again is another company (adding to Yaskawa, Sandvik (OTCPK:SDVKY), and Stanley Black & Decker (SWK) ) pointing to growing headwinds in the auto business, with the trouble in Europe going beyond the emissions testing bottlenecks. It will be very interesting to see what ABB (ABB) given, that company’s strong position in robotics in China and the auto market.
With management expecting these headwinds to last for at least a little while, they lowered their growth guidance for next year to 35% to 40% and lowered their annualized growth target out to 2022 from 50%-55% to 30%-40%.
Intending no disrespect to Teradyne management, I’m not sure I believe that is due solely to macro issues. I believe ABB and Yaskawa are catching up in cobots faster than Teradyne analysts appreciate, and ABB in particular has the advantage of a more complete ecosystem of factory automation technologies (though Teradyne’s ecosystem behind its cobots is impressive). This isn’t the Highlander and in the end there can be more than one, and I believe Teradyne will continue to benefit from strong demand for these smaller, cheaper, safer robots, not to mention the warehouse/logistics applications for its MiR platform.
The Outlook
Between increased challenges in the semiconductor industry and greater headwinds in robotics markets like auto, I’m reducing my near-term revenue growth and margin expectations. I still expect long-term revenue growth to be somewhere in the mid-to-high single-digits (or whatever you call around 7%), with annualized FCF growth close to 10%. I expect the large majority of growth to come from the industrial automation business; new chip architectures and 5G are growth opportunities for testing, but I don’t believe this is a structurally high-growth market.
The Bottom Line
Discounting those cash flows back, I think Terdayne should still trade in the high $30’s to low $40’s, suggesting some upside even after the strong post-earnings reaction. It is looking like 2019 will be a more challenging year for many companies, and I think there are risks of further cuts to overall growth expectations, but I believe the near-term risks to Teradyne are tempered by attractive long-term growth opportunities in robotics and a stronger position in higher-value semi testing areas like MCUs.
