Teradyne Hindered By Near-Term Guidance, While The Long-Term Outlook Is Attractive

 

The last year and a half has been a strong one for Teradyne (TER) from an operational standpoint, as strong testing demand at leading-edge nodes has driven a stronger-for-longer cycle that has exceeded even the bullish expectations of a few years ago.

That hasn’t necessarily translated into runaway success for the shares, though, as the 85% or so total return since my last article has underperformed the returns of major semi equipment companies like ASML (ASML), Applied Materials (AMAT), and Lam Research (LRCX), and slightly lagged the SOX itself. Fellow test equipment maker Advantest (OTCPK:ATEYY) has largely kept pace, while probe test card manufacturer FormFactor (FORM) has noticeably lagged, particularly since the spring of this year.

Expectations are hardly low here, and the testing business has shown significant year-to-year cyclicality in the past. I still believe that cyclicality can be a risk to future short-term performance, but I don’t see a compelling reason why test equipment growth can’t continue at a “high mid-single-digit” rate, supplemented with strong growth in the Industrial Automation business as cobots continue to see adoption in multiple end-markets. As that can fuel a high single-digit long-term annualized total return, relatively good by the standards of the semi equipment space (broadly defined), this could still be a name worth considering.

 

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Teradyne Hindered By Near-Term Guidance, While The Long-Term Outlook Is Attractive

Complexity, Enterprise, And Share Gains Are All Still Boosting Teradyne

Teradyne (NASDAQ:TER) is going to go down as another example in my book of how you shouldn't underestimate companies holding a hot hand. While it has been some time since the shares have been conventionally cheap, the company has continued to exceed expectations on a combination of increased testing complexity, growth in key markets, and market share growth with new products.

Surprising to me is that the shares have actually lagged the SOX a bit since my last update. The outperformance on a trailing one-year basis is still meaningful though, and Teradyne bounced back well from the March lows. Valuation looks quite reasonable now, which actually worries me - is the Street starting to price in a second-half slowdown and shifting away in anticipation, or is this just an underappreciated story at this point?

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Complexity, Enterprise, And Share Gains Are All Still Boosting Teradyne

Teradyne Still On Fire, With 5G And Memory Test Chipping In

Even by the standards of semi equipment, Teradyne (TER) has been on a tear, with the shares more than doubling over the past year (compared to the paltry nearly 70% gain at Applied Materials (AMAT) and 75% gain at ASML Holding (ASML)). Then again, with Advantest (OTCPK:ATEYY) up about 180% and FormFactor (FORM) up more than 100% as well, it’s pretty safe to say that the wafer testing market has been a good place to be, as demand from logic customers has definitely improved heading into 2020.

Sustainability and valuation were my primary concerns going into this quarter, and they remain my primary concerns. Management’s guidance suggests a year weighted to the first half, and it may well prove to be the case that 5G demand in China was artificially elevated by concerns about future restrictions on access (essentially pulling demand forward). As far as valuation goes, I know growth and momentum investors won’t care, but it’s tough to reconcile today’s price with a reasonable set of long-term growth expectations. The best I can do is to say that, within the spectrum of where semi equipment stocks trade today, the company’s valuation is not so unreasonable. Make of that what you will.

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Teradyne Still On Fire, With 5G And Memory Test Chipping In

Teradyne At A 15-Year High On Strong 5G Demand

Better than expected testing demand related to 5G has been a real boon for Teradyne (TER) this year, driving meaningfully higher demand for system-on-a-chip (or SoC) testing, including better-than-expected results in the third quarter and much, much better guidance for the fourth quarter. With that, the company is on pace for roughly 7% growth this year, against expectations at the start of the year for a modest decline due to the wider slowdown in the chip sector, and the shares are at their highest level in almost 20 years.

I underestimated the near-term demand for 5G infrastructure testing and the extent to which it would drive such a strong second half, but the valuation multiples are about double the long-term norm now, and while Teradyne should see several years of double-digit growth, the market seems to be more than fully pricing that into the shares today.

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Teradyne At A 15-Year High On Strong 5G Demand

Teradyne Benefiting From Earlier, Stronger Orders For 5G, Handsets, Wireless, And Memory

I thought Teradyne (NASDAQ:TER) looked undervalued on excessive pessimism back in January, but I didn't see this 60% run in the shares, as Teradyne has managed to keep putting together strong quarters relative to expectations, sending sell-side estimates higher along the way. Although there were some fears going into this quarter that Teradyne was "pulling in" demand from later in 2019, I'm not so sure that theory holds water anymore.

The record Teradyne has relative to earnings expectations is impressive, so much so that I have to wonder whether management plays it intentionally too conservative just to give themselves leeway. Whatever the story may be on that, the fact is that the company is seeing good semiconductor test demand and is gaining share in memory, while the near-term headwinds in industrial automation have been pretty well anticipated by the market. Valuation is no longer attractive, though, and I don't see that same "hey, it's not so bad" trade opportunity that I did before.

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Teradyne Benefiting From Earlier, Stronger Orders For 5G, Handsets, Wireless, And Memory

Fanuc Beaten Down On Sharp Order Declines

Japanese automation leader Fanuc (OTCPK:FANUY) (6954.T) has a loyal shareholder base that can lean toward the fanatical, but the last couple of quarters underline that for all of Fanuc’s quality, it’s not immune to macro-driven cyclicality. What’s worse, competition has ramped up in many of the company’s businesses and management’s projections that conditions won’t get significantly worse may prove too optimistic.

From where I sit, the argument that Fanuc is too cheap now only works if you expect a pretty dramatic reversal (basically a V-shaped recovery) in recent machine tool and automation demand trends in China and a quick return to double-digit ROEs. I don’t believe that’s going to happen, and I think Fanuc has more vulnerability to traditional rivals like ABB (ABB) and Yaskawa (OTCPK:YASKY), non-traditional rivals like Teradyne (TER) and local Chinese automation companies, and shifting market trends than its more bullish supporters acknowledge.

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Fanuc Beaten Down On Sharp Order Declines

Teradyne Guidance Brings Relief, But The Near-Term Looks Challenging

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 (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.

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Teradyne Guidance Brings Relief, But The Near-Term Looks Challenging

Teradyne's Cobot Opportunity More Than Just Hype

What makes Teradyne (TER) interesting is the combination of a high-share, margin-rich, cash-flow-generating semiconductor test business with an emerging growth story in collaborative robots (or "cobots"), a high-potential new segment of the robotics market where Teradyne has established a strong initial market share and a business plan and ecosystem that may make it harder for established robot players like Fanuc (OTCPK:FANUY), Yaskawa (OTCPK:YASKY), and ABB (ABB) to muscle Teradyne aside and replicate their traditional shares of the robotics market.

Although there will be some above-trend years and Teradyne is a net beneficiary of increasing chip content and complexity, I believe the core semiconductor test business is a solid but not spectacular business. The cobot business, though, has legitimately exciting potential and should be the key driver of what I expect to be high-single-digit long-term revenue growth and double-digit FCF growth over the next 10 years.

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Teradyne's Cobot Opportunity More Than Just Hype

National Instruments Already Getting Ample Credit For What It Does Well

Although Wall Street often values companies on the basis of their perceived potential in the short term, it's typically a company's ability to execute that determines the long-term rewards for shareholders. That makes National Instruments (NASDAQ:NATI) a tough stock for GARP investors today; while the company's long-term revenue growth hasn't been bad, margin leverage has been elusive and returns on capital haven't been impressive. Making matters more complicated, the company's strong presence in software and its uncommon modular approach ought to be valuable points of distinction.

There are a lot of potential drivers that could lead to meaningful changes in National Instrument's future performance. The company is more aggressively targeting opportunities in semiconductor and wireless test, and the company's capabilities in embedded monitoring and control could leverage meaning growth in industrial IoT, autonomous vehicles, and other "smart machine" applications. Could is a tricky word, though, and a lot of improvement (and/or M&A potential) seems to be in today's share price.

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National Instruments Already Getting Ample Credit For What It Does Well

Yaskawa Electric Leveraging The Automation Of China

Having established itself as a leader in multiple segments of the Japanese factory automation sector, Yaskawa Electric (OTCPK:YASKY) is trying to repeat its success in China as that country increasingly adopts automation. The company has done well thus far, but the cyclical nature of the industry and its dependence upon customer capex (not to mention forex exposure) have made for choppy share price performance over the past five years.

The shares are now off more than 10% from their recent high and look as though they could be slightly undervalued. I'm not looking for exceptional revenue growth in the coming years, but I do think the company can improve its margins and continue to leverage its strong share in servomotors. If adoption of servomotors, inverters, and robots can spread beyond today's core markets (and if Yaskawa can broaden its horizons in robotics), there could additional upside to sweeten the prospects.

Yaskawa's ADRs are not especially liquid. I would suggest that investors consider the Japan-listed shares instead.

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Yaskawa Electric Leveraging The Automation Of China

Teradyne Should Redeploy Capital Toward Growth

Not all semiconductor equipment is the same, and while Teradyne (NYSE:TER) is essentially a co-duopolist with Advantest (NYSE:ATE) in the back-end semiconductor test space (and a pretty well-run company on balance), it's hard for me to see this market offering a lot of attractive long-term growth opportunities. It does tend to support solid margins and cash flows over the full cycle, though, and that gives Teradyne the resources to consider its long-term options.

As is, I think Teradyne is basically fully valued today. The "but" is that the company has a healthy balance sheet and the opportunity to buy its way into new growth markets. The company's early position in collaborative robotics is one such example, and there are a lot of places Teradyne could go in industrial automation from here. By the same token, the company could make complementary acquisitions to augment existing test businesses; these deals wouldn't likely be growth drivers, but could make sense from longer-term synergy and cash-on-cash return perspectives.

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Teradyne Should Redeploy Capital Toward Growth

Xcerra Waiting For The Next Elevator In The Testing Cycle

It has been a while since I've written about Xcerra (NASDAQ:XCRA), a small hyper-cyclical player in the semiconductor test market. When I last wrote about the company, I thought the shares looked undervalued below $12.50 in May of 2014. The shares did break into the $10s a few times after that, but the momentum in the system on a chip (or SoC) testing market faded faster than expected and Xcerra took an all-too-common cyclical tumble back into the mid single-digits.

The shares do appear undervalued again today, and the company is addressing new markets that meaningfully expand its total potential revenue opportunity. That said, Teradyne (NYSE:TER) and Advantest (NYSE:ATE) have commanding share in the industry and it's far from certain that Xcerra's new opportunities are going to work out as hoped. I can see the appeal here for risk-seeking investors who want to find a high-leverage play on increased semiconductor equipment spending, but I think this is definitely the sort of stock you "date" as opposed to making a long-term commitment.

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Xcerra Waiting For The Next Elevator In The Testing Cycle

Seeking Alpha: Super-Cyclical Xcerra Seems To Have More Left In The Tank

Semiconductor companies have enough cyclical volatility to frustrate most investors. Semiconductor equipment companies are even worse. Semiconductor test equipment is its own special corner of cyclical-hell, as peak-to-trough moves can easily exceed 66%. What goes down can go up again, though, and while Xcerra (XCRA) (LTXC) has more than doubled over the past year, momentum in the testing market and the stock's valuation suggests there could still be more gains in store.

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Super-Cyclical Xcerra Seems To Have More Left In The Tank

Investopedia: Agilent Isn't Making It Easy On Investors

It's getting harder for me not to view Agilent (NYSE:A) as something like the store-brand version of Danaher (NYSE:DHR). It's cheaper and pretty close to the real thing, but it's just not quite the same and sometimes those differences leave you walking away unsatisified. To be sure, I think Agilent could do a lot to close this gap, but I'm not sure they will. Consequently, while Agilent is a little bit undervalued, it's harder for me to be as enthusiastic about buying shares today – particularly when Danaher seems undervalued to a similar degree.

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Investopedia: If The Economy Holds, Agilent Is A Buy

Put succinctly, Wall Street is still freaked out about the course of the global economy in 2012. As a result, a long list of companies are trading below what seems like a rational fair value, and Agilent (NYSE:A) is clearly among them. Although a further economic slowdown would be bad news for both the test and measurement and life sciences businesses, today's price seems to already factor in a lot of that risk.

An Unnerving Close to the Fiscal Year  
Although Agilent's reported results were not bad, it did give nervous investors an excuse to worry a little more. Revenue did rise more than 9% in the fiscal fourth quarter, but the growth rate came in a bit below the expectations of management and many analysts, even if that shortfall could be tied largely to forex moves. Growth was strongest in the electronic measurement segment (up 10% organically), decent in life sciences (up 6%) and sluggish in chemical analysis (up 1%).

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http://stocks.investopedia.com/stock-analysis/2011/If-The-Economy-Holds-Agilent-Is-A-Buy-A-DHR-TER-TMO-ILMN-LIFE-NATI-TMO-XXIA-EXFO1123.aspx

Investopedia: Agilent Overshoots

It really was not so long ago that electronic measurement, chemical analysis and life sciences conglomerate Agilent (NYSE:A), was overlooked, under-followed and trading at a discount to its intrinsic worth. The market is always changing, though, and Agilent now trades much more like a popular growth company with multiple revenue drivers.


A Strong Second Quarter
Inherent to the Agilent structure is the idea that the more stable life sciences group can offset the more cyclical electronic measurement business. Right now, though, both are doing quite well. Total revenue rose 32% in the second quarter, or 21% on an organic basis. Growth was led by the chemical analysis growth, with a 60% jump in reported revenue, though life sciences and electronic measurement did fine at 39% and 19%, respectively. Order growth of more than 26% (18% organic) was also encouraging, though this number seems to be decelerating.

Gross margin did decline on a year-over-year basis (55.4% versus 56.9%), one of the few blemishes of the quarter. Operating income, though, grew more than 61% and the operating margin jumped three and a half points on controlled SG&A and R&D spending. Agilent still spent close to 10% of its revenue on R&D, though, so it is not as though Agilent is robbing the future for present growth.


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