Targeting tech stocks that buck the bear
By Lisa Meyer
Red Herring
March 15
To help calm the fears that pushed investors to panic selling earlier this week, Red Herring decided to focus our weekly stock screen on the bright spots in the technology sector. This is not to say that increasing worries about the slowing economy and declining corporate earnings aren't valid. But not all technology stocks are depressed. Even though investors may be surrendering any notion of safe havens, some still do exist.
Using the Thomson Financial/Baseline database, Red Herring found an eclectic group of stocks that have not been brutally sold off this year. First, we searched for companies in the technology and communications sectors that have traded higher since the beginning of the year and during the last month. To increase the likelihood that such a strong performance will continue, we required that the companies have estimated earnings growth for this year of at least 20 percent. We also searched for companies with reasonable valuations, trading at price-to-earnings ratios below their long-term growth rate. Finally, for this screen, we wanted companies with a market capitalization of at least $200 million.
The result was nine companies, spread throughout the software, electronic instruments, electronics distribution, semiconductor, and semiconductor equipment sectors. They include Avnet (NYSE: AVT), Titan (NYSE: TTN), DRS Technologies (AMEX: DRS), BEI Technologies (Nasdaq: BEIQ), Nvidia (Nasdaq: NVDA), KLA-Tencor (Nasdaq: KLAC), Lam Research (Nasdaq: LRCX), Semitool (Nasdaq: SMTL), and eFunds (Nasdaq: EFDS). Data are current as of March 14.
After taking a look at these nine companies, we decided to focus on three that appear to be especially promising: BEI, eFunds, and Titan.
It is worth noting, however, that two of the companies that made this week's screen did appear a month ago in a Stock Screen column on defensive plays in a bear market. Chip equipment companies KLA-Tencor and Lam Research are still attractive buys because they are trading at valuations below their long-term growth rates. KLA is trading at 22 times its estimated 2001 earnings, but is expected to grow its earnings at a 25 percent clip during the next three to five years, whereas Lam's stock is at 16 times its estimated 2001 earnings, but its long-term earnings growth is 22 percent.
Red Herring also recently addressed the success of graphics chip maker Nvidia. The bear market dodger has outperformed its competitors on Wall Street, logging a 74 percent price since January 1 and a 32 percent surge in the past month.
BEI BEATING THE BEARS
Because of its diversified customer base, BEI Technologies has been able to sustain strong revenue and earnings growth at a time when many technology plays are announcing warnings and posting shortfalls. Indeed, BEI, which makes sophisticated sensors for use in cars, trucks, military gear, and semiconductors, could provide shareholders with healthy gains in the next several quarters due to the increased demand for such sensors, which prevent rollovers in sport utility vehicles.
About half of BEI's business comes from the automotive market, less than 10 percent comes from the defense industry, and the remainder comes from consumer applications like copiers, according to Jeff Tryka, an analyst at Red Chip Review, a research firm. With little exposure to the beleaguered semiconductor sector, BEI has been able to skirt the recent market downdraft. Much of BEI's motion-control products are not sold directly into the semiconductor market, but rather to vendors creating systems for that market.
Key to the company's success has been its ability to convert its traditional business of building defense and aerospace stability-control applications for use in the commercial market. 'Even though the growth in the defense business has slowed, it still brings the company about $25 million a year,' says Mr. Tryka. More significantly, BEI has been able to apply some of its defense technology to other businesses, like automobiles, he says.
The company also has cut costs by decreasing the size of its sensors so that less material and capital are needed for their creation. Such leveraging of production assets has paid off. For its fiscal 2001 first quarter, BEI reported gross margins of 29 percent, versus 26.4 percent for the same quarter last year. And investors rewarded such efficiency by bidding up the company's stock price 42 percent since the beginning of the year and 27 percent during the past month. Despite this upside, BEI's stock is still an attractive buy, trading at 21 times its estimated 2001 earnings, while company earnings are expected to grow 25 percent over the next three to five years.
EFUNDS IS NOT A MONEY-LOSING DOT-COM
EFunds is another technology play that has held up well in an ugly market. A provider of electronic debit payment solutions, eFunds is not, as its name implies, an Internet play. Even though the company is starting to focus more on facilitating debit payments over the Net, eFunds gains most of its business from providing transaction-processing tools to brick-and-mortar financial institutions and retailers. Electronic payment company NYCE Corporation did announce on Wednesday that eFunds would provide an Internet gateway for NYCE's SafeDebit, a Web-based transaction system. 'No matter what happens to the economy and to dot-coms, people still need to use debit and ATM cards,' says Per Ostlund, an analyst with research firm Miller Johnson Steichen Kinnard.
And the company's steady profitability demonstrates that need. In 2001, analysts expect eFunds to post a 174 percent year-over-year increase in earnings per share, from 31 cents to 85 cents, according to First Call. The reason for such a steep spike is partly due to the company's growing visibility. EFunds recently completed its spin-off from Deluxe Corporation (NYSE: DLX ), an electronic transaction services and paper payments provider. As a separately traded public company, eFunds will no longer be overlooked by investors that had no interest in its slower-growing former parent.
'While many tech companies are trimming expectations, eFunds, whose earnings have yet to be adjusted, is sounding even more confident in what it's doing,' says Mr. Ostlund. Before the spin-off was complete, eFunds had been several different businesses. 'Now that the company has the management of all its operating divisions on the same page,' he adds, '[it] is able to take some layers of cost out and make a more cohesive product and service offering.'
Investors have applauded such changes, bidding up the shares 100 percent since January 1, and 15 percent in the last month. But the stock is still fairly valued in our opinion, currently trading at 23 times its estimated 2001 earnings, even though the company's expected long-term earnings growth rate is 30 percent.
TITAN'S TAKE
Titan is another company reaping the benefits of a rare sweet spot in the tech market by providing information technology and communications solutions to the U.S. and allied government agencies. Titan was recently awarded two Navy subcontracts valued at approximately $150 million over the next five years. 'More than 80 percent of Titan's business is government related, and that business's visibility goes out several years with an order backlog valued at $2 billion,' says Stephen Levenson, an analyst at Gerard Klauer Mattison.
Like BEI, Titan has successfully brought its technology into commercial markets. Revenues for Titan's e-business solutions subsidiary Cayenta increased 31 percent to $21.7 million in the fourth quarter, from $16.6 million during the same period a year ago, which is primarily due to growth in the company's enterprise application integration and hosted solution businesses. Titan's satellite communications subsidiary, Titan Wireless, and its emerging technologies and businesses segment also showed strong revenue gains.
But by far the star performer is SureBeam, Titan's food pasteurization subsidiary. It increased its revenues 162 percent to $9.8 million in the fourth quarter from $3.7 million during the same period last year, driven by the sale of systems to a Brazilian company. As of March 14, SureBeam was on tap to sell 6.7 million shares at $10 to $12 each in a $73.7 million IPO this week. Such an offering further validates Titan's commercial businesses, says Mr. Levenson.
But the recent increase in the company's stock price might be enough evidence. Since the beginning of the year, shares have risen 27 percent, while during the past month, the price of the stock has spiked 1.7 percent. Despite these upticks, the stock is trading at a reasonable valuation: 24 times its estimated 2001 earnings, with a long-term growth rate of 36 percent.
So, with some research, technology investors can still find winners in today's market. Times may be tough for technology, but even in the worst of markets, the savvy investor should be able to find some diamonds in the rough.
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