COHU - Cohu: Inspection Play Warrants A Further Inspection

2023-11-06 15:25:43 ET

Summary

• Cohu is a niche player in the semiconductor industry, offering a broad portfolio of equipment and services for back-end manufacturing.
• The company has seen solid growth, with revenues nearly quadrupling in a 7-8 year window.
• However, recent headwinds in the industry have led to declining sales and profitability, raising concerns about the company's near term earnings power.

Cohu ( COHU ) describes itself as the only company with expertise on the entire test cell inspection process in the semiconductor industry. The company has built up a nice little position as a niche player and has seen solid growth. Despite a long term growth story, Cohu is hit by current headwinds in the industry, which are lasting for a while, but should stabilize anytime soon.

Given all these trends, I am taking a wait-and-see approach, although that Cohu's long-term growth and strong balance sheet warrant a position on my watch list from hereon.

Perspective On This Test Cell Inspection Business

Cohu offers a broad portfolio of equipment and services for back-end semiconductor manufacturing. This includes being a one-stop-shop solution for test and handling equipment, thermal subsystems, test contracting and vision inspection, among others.

While the company is really a smaller niche player, it has a rich history, being founded in 1947 already. A $1 stock in the early 1980s saw massive price gains and volatility surrounding the internet bubble, as shares have mostly traded in a $10-$20 range from the internet bubble until the outset of the pandemic.

A $20 stock pre-pandemic rose to a high of $50 in 2021 when many (semiconductor) firms were moving higher, after which shares have traded stagnant and range bound between $20 and $40 per share.

With the company's services improving the yield and productivity of its end clients, the services offered by Cohu are in great demand, and hence Cohu has seen decent growth in recent years. A quarter of a billion business in the 2015s has grown sales to nearly $900 million in 2021. Revenues nearly four folding in a 7-8 year window is impressive, but Cohu and its investors have seen the share count nearly double over this period of time as well.

This was due to acquisitions as well as the fact that not until the most recent years, earnings power was rather mixed, with no sustainable GAAP earnings reported for quite a while.

A Base Case - 2022 Results And Performance So Far

Going back to February of this year, Cohu posted its 2022 results, a year in which revenues were down more than 8% to nearly $813 million. Despite the revenue declines, the company maintained superior profitability with operating profits reported at $125 million on a GAAP basis, and that is after a $33 million amortization charge.

The company posted GAAP earnings of $1.98 per share and adjusted earnings at $2.91 per share. About two-thirds of the gap is explained by amortization charges, which I am happy to adjust for and the remainder by stock-based compensation expenses, which I am not happy to adjust for. This suggests that realistic earnings are seen around $2.60 per share. The company operated with a net cash position of around $300 million as well, equal to more than $6 per share.

Given all this, the prevailing share price in the mid-thirties actually looked quite reasonable. The reason for that undoubtedly has to do with the further retreat in sales. Fourth quarter sales for 2022 had already fallen to $191 million, as a $173-$187 million guidance for the first quarter of 2023 did not look too compelling.

While first quarter results came in line with the midpoint of the guidance, second quarter sales were seen just between $161 million and $173 million. In August, Cohu posted second quarter sales at nearly $169 million, yet this relative optimism faded quickly as third quarter sales were seen down to just $150 million.

Early in November, Cohu posted third quarter sales at nearly $151 million, down 27% on the year before. This has started to weigh heavily on profitability with third quarter GAAP operating profits down from $33 million this period last year to $7 million in the third quarter of this year.

This results in GAAP earnings of just $0.08 per share with earnings even aided by net interest income. Adjusted earnings came in at $0.35 per share, with again two-thirds of the gap being the result of amortization charges, and the remainder from stock-based compensation expenses.

And Now?

Just ahead of the announcement of soft third quarter results, the company announced the purchase of Equiptest Engineering Pte, also known as EQT, which is a provider of semiconductor test contractors and consumables.

The deal will add some $20 million in sales, equal to about 3-4% of the current revenue base, as no purchase price has been announced in the press release, but the third quarter earnings presentation suggests that a $48 million cash component was involved. The 2.4 times sales multiple is largely in line with the own valuation at around 2 times sales.

While a growing net cash balance of $346 million (pre EQT) builds up to over $7 per share based on a share tally of 48 million shares, the issue is that of the earnings power, or better said lack thereof. With shares now down to $31, the operating asset valuation comes in at $24 per share, yet we have seen before that realistic earnings only trend around a dollar per share here. Moreover, part of these earnings come from net interest income, but there is no quick avail with fourth quarter sales seen at just $130-$142 million, likely not boding well for earnings and margins as well.

Right now it seems as if the company continues to struggle, with sequential revenue declines reported again and again here. This is somewhat disappointing given the diversified client base and industry exposure. It is the focus on efficiencies is what drives the business of the clients of Cohu, and with the industry far from running red-hot, efficiency is not most needed here with sufficient capacity available.

Given all this, I am not yet willing to get involved here, yet with growing cash balances and long term growth (potential), I am willing to keep a close eye on the business from here. For me to get involved, some stabilization in sequential revenues is badly needed, to be accompanied by margins expansion, to drive potential appeal here.

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