TER - Advantest: Cheaper And Superior To Teradyne

Summary

• Advantest has significantly outperformed key peer Teradyne over the last 5 years, by increasing market share and boosting its earnings trajectory.
• Current market conditions are difficult, but the positive secular growth theme in semiconductor testers remains intact.
• With Advantest trading at notable discounts to Teradyne, we rate the shares as a buy.

Investment thesis

Advantest ( OTCPK:ATEYY ) has made giant strides in the semiconductor tester market to significantly outperform Teradyne over the last 5 years. Current market conditions are difficult due to inventory adjustments, but the secular growth theme remains intact and the company is set to outperform in our view. We rate the shares as a buy.

Quick primer

Founded in 1954, Advantest produces measurement instruments used primarily in the semiconductor industry for R&D and quality assurance. These instruments are primarily testers for both logic and memory chips to ensure they operate according to design and specifications. The company has around 50% market share of the tester market, with the core peer being Teradyne ( TER ). Advantest's key geographic markets are in Asia, catering to the regional chipmakers in South Korea, Taiwan, and China, and it is relatively strong in memory testers. Teradyne also has the majority of sales in Asia but also has an industrial automation business with Universal Robots cobots and autonomous mobile robots.

Key financials with consensus forecasts

Our objectives

The last five years have been a major boom period for the semiconductor industry, driven by 5G, AI, crypto, cloud adoption, and new workstyles adopted due to the pandemic. This was a major secular driver for businesses involved both in the front and back end of semiconductor production equipment. Over this period, we note that Advantest has significantly outperformed its key peer Teradyne.

In this piece, we want to understand the reasons behind this outperformance, and whether such a trend is sustainable.

Major differences in track record

With major growth in the total addressable market and effectively operating in a duopoly, the simple conclusion is that Advantest has been making strides in gaining market share. The company estimated it had a 36% market share in CY2017; although there have been fluctuations, CY2021 was estimated to be at 47%. This major advancement was made possible via a combination of two key factors: 1) a strategic shift to expand into the SoC (System-on-a-Chip) testing market in 2010, with the successful acquisition of US company Verigy, and 2) continued bolt-on M&A to strengthen Advantest's product offering, building up its expertise over the complicated global SoC supply chain.

Advantest's track record speaks for itself. The 5-year CAGR for sales and earnings as well as book value is far superior to Teradyne, with sales growth at nearly three times and EBIT growth five times faster.

5-year CAGR performance

It is also noteworthy that both free cash flow margins and returns have vastly improved over the same period, with ROE rising over 20%. Teradyne has seen free cash flow margins drop.

5-year change in margin and returns

The other major difference between the two companies is Teradyne's exposure to robotics, via Universal Robots ("UR") (a cooperative robot and automation company that was established in Denmark in 2005) and mobile industrial robots. Acquired in 2015, the UR business has been burning cash since the acquisition, and despite very high expectations over the adoption of 'cobots' in all tiers of manufacturing, low barriers to entry and lack of demand have been problematic. As Advantest has stuck to its core business, its returns have continued to expand at an accelerated pace.

Outlook going forward

The semiconductor market is currently undergoing a period of an inventory correction, and demand for testers has fallen due to customer postponements due to macro uncertainties as well as soft end-user demand. Despite the semiconductor industry's susceptibility to the ebb and flow of supply and demand, the secular growth theme remains firmly in place. Advantest has been continually investing in R&D and M&A, and with management referring to a large order backlog in Q3 FY3/2023 ( page 17 ), short-term earnings visibility remains high.

Whilst consensus forecasts estimate Advantest's FY3/2024 sales to decline by 5.3% YoY (see Key financials table above), we note that expectations are for a much steeper decline for Teradyne into FY12/2024 at -10.1% YoY, followed by a steeper recovery profile in FY12/2025.

Consensus forecast outlook for Teradyne

We conclude that there will be continued fluctuations in demand for testers in the future, but secular growth should underpin an attractive long-term earnings trajectory for Advantest.

Valuation

On consensus forecasts, Advantest's shares are trading PER FY3/2024 17.8x, with a free cash flow yield of 5.6%. We contrast this with Teradyne, trading on PER FY12/2023 32x, with a free cash flow yield of 3.7%. The prospective estimated ROE is 28.4% for Advantest, and 20.4% for Teradyne.

Risks

Upside risk comes from Advantest continuing to drive up market share, as the company continues to execute its strategy of expanding successfully into SoC testers via M&A.

Accelerating demand from key industries such as automotive, AI, and wireless with the increasing adoption of EVs, and the build-up toward 6G (in 2030).

Downside risks come from forex translation with a strengthening Japanese yen, providing negative optics despite underlying demand.

Restrictions on exports to China may become a major negative issue, given its growing significance in the semiconductor industry.

Conclusion

Advantest looks like a textbook example of a business making a successful strategic shift, making steady progress, and becoming a high-return business. What is quite startling is its continued low profile versus Teradyne and its outperformance. The company has transformed to improve its earnings trajectory, and we believe is a better investment than Teradyne. We rate Advantest shares as a buy.

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