Stock of the Day
Jan 20, 2000
Teradyne: Chip Gear is Hot, Demands Vigilance
The semiconductor industry is thriving these days, and that means companies selling equipment to the chip makers are thriving as well. Teradyne (NYSE:TER - news) sells automated testing equipment for semiconductors and other electronic products. The company just reported another strong quarter, prompting several analysts to raise earnings estimates and price targets for the stock.
At times like this, investors need to remember that chip equipment is a violently cyclical business. When the tide turns, it turns hard. Teradyne's stock peaked well before each of the past two cyclical downturns in the chip industry, falling roughly 70% from its highs each time. So even as the outlook for companies like Teradyne has never been better, investors can't relax and just let the good times roll. There is probably still plenty of money to made here -- all the industry analysts certainly think so -- but it should be earned and preserved by investors staying ever-vigilant for signs of an end to the current cycle.
There were no such signs of an impending turn in Teradyne's fourth quarter report. Earnings per share jumped from $0.07 a year ago to $0.42, beating the analyst consensus by 3 cents. Sales rose 73.5% to $548.5 million. Of course, comparisons to a year ago are easy because the chip equipment industry was still in a terrible slump. Perhaps of more significance was the sequential growth in orders to $685 million versus $491 million in the third quarter and a prior record of $571 million in the second quarter.
Several analysts responded with bullish comments, increased earnings estimates and higher price targets. Credit Suisse First Boston set a new price target of $95. Teradyne closed Wednesday at $77.25, up 140% since we profiled it in October. The semiconductor industry still appears to be in the early innings of a strong up-cycle, but with the stock up so sharply it is more vulnerable to issues like rising interest rates and potential disruptions to order flow.
One factor in Teradyne's favor is that the semiconductor industry is at a point in the technology curve where it's time to retool for higher device speeds. Many of the big chip makers have been announcing 0.21 and 0.18 micron products (vs the old 0.25 micron standard), so in order to deliver they will have to make substantial equipment investments. New memory architectures such as the Rambus-based RDRAM chips appear to be adding to the demand momentum.
Some of Teradyne's machines sell for several million dollars a piece. These systems are used by semiconductor manufacturers to verify the electrical characteristics, performance and reliability of each chip before it is shipped. The company derives only about 12% of its revenues from the memory chip segment, while the more attractive mixed signal chip market accounts for 45% of its revenues. Mixed signal chips are used in automotive, computer peripheral, telecom and wireless device applications. Mixed signal is expected to be one of the fastest growing segments of the semiconductor industry, so Teradyne's competitive lead in this area is a major asset. The company also sells testing equipment for logic chips, another strong area of the semiconductor industry. Logic tester products account for roughly 25% of revenues.
Teradyne has made a concerted effort to grow its non-chip testing business, in part to dampen some of the cyclicality in semiconductors. Its telecom line test systems are doing well. Software-based testing is another small but growing component of the business, and it offers exceptionally high margins.
The company also generates revenues from backplane assemblies. These are large printed circuit boards which serve as the central interconnect plane for daughterboards. Rather than standard motherboards like what you find inside a PC, Teradyne makes custom backplane assemblies for proprietary applications in communications, data storage equipment and defense/aerospace.
Teradyne isn't one of those sexy, front-line tech stocks that investors like to brag about owning in their portfolio. But it does offer a behind-the-scenes way to participate in the chip industry boom, with diversified end markets from computers to communications. The key for investors with a stock like this is to always remain vigilant for an end to the current up-cycle. |
