Barron's this week on TER
Q: You mentioned the semiconductors as a favorite, but you liked them a year
ago, too.
A: We did like semiconductors a year ago. We had little or no exposure and
bought some. Their fundamentals improved, and the stocks ran up on the back of
that and a turn in the economy. It was a case of too much optimism, too fast. We
weren't going to see big margin and pricing improvements in a short period when
the industry was operating at 70% of capacity, which it was a year ago. The
market began to realize this was an intermediate-term story as opposed to a
short-term story and grew impatient with tech.
When the economy started decelerating in May, the tech stocks, the chip stocks,
and cyclicals in general, sold off. We got rid of a good portion of our tech
holdings in the first quarter, though not all of them. We should have sold all of our
exposure, obviously. But we've been repurchasing what we sold and bought more
in the summer.
Q: Where are you focused?
A: On the less glamorous, back end of the semiconductor industry -- companies
that do the assembly and testing of the equipment. The back end is more affected
by unit volume as opposed to pricing. And utilization is very high because there
was less of a bubble in back-end spending.
Q: Which back-end companies do you like?
A: The company we favor most is Teradyne, the worldwide market leader for
automated test equipment in the semiconductor industry. They also have a smaller
electronic manufacturing-services business. In their main test-equipment business,
customer-utilization rates are about 80% and have been going up steadily for 14
months. Agilent Technologies, one of its competitors, has customer-utilization
rates in the 90s. And LTX's capacity-utilization rates are in the 80s. A 100% rate
is impossible, so a mid-80s to low 90s is close to effective capacity. Eventually,
the customers will have to order new test equipment as they develop more
confidence in their order books.
Q: Why focus on Teradyne over Agilent?
A: Teradyne is a pure play. Agilent is a good company, and we own Agilent, but
only about 20% of Agilent's business is in the test side. But Teradyne is in its
strongest new-product cycle ever. They have just lowered their break-even point
to $450 million per quarter in sales. And the test market is a real growth segment,
forecast to grow about 20% a year. The stock is now well below its book value of
$9 a share and we think that they have peak earnings of more than $3 a share.
Teradyne should earn 25 cents a share in 2003, but this year and next year are
trough earnings, then it will move toward its peak earnings
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