Stock Screen
Semi-Obscurity Has Its Advantages
By Jack Hough
May 20, 2004
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YOU'VE HEARD OF Roger Bannister, but do you know who ran the world's second sub-four-minute mile? You've seen thousands of drawings of George Washington, but do you know what second president John Adams looked like?
Talk about diminishing returns. No. 1s in this world become household names, while No. 2s are forgotten. (The answers to our questions are John Landry, and a cross between Larry David and Don Rickles.) Today we'll look at the world's No. 2 maker of semiconductors, whose annual sales are less than half that of the industry leader. Shares of this little-known giant may be cheap right now; they turned up recently on our Unheard Of screen.
Why look through less-recognized companies for bargains? Because familiarity makes investors comfortable, and many are willing to pay a premium for it. So industry leaders often have pricey shares. The case can be made, of course, that industry leaders have certain advantages of scale over smaller rivals, and therefore deserve higher price/earnings multiples. But when you normalize companies' P/E ratios for the rate at which analysts project their earnings will increase (using price/earnings growth, or PEG, ratios), that argument isn't always convincing.
Top liquor seller Allied Domecq (AED) has trailing-12-month sales of $5.9 billion and a PEG of 1.45. Runner-up Constellation Brands (STZ) sold $3.6 million worth of loudmouth punch last year, and has a PEG of 1.07. The same thing goes for No. 1 cleaning-products seller Procter & Gamble's (PG) PEG of 2.10 vs. No. 4 Church & Dwight's (CHD) PEG of 1.53. (See our recent write-up of Church & Dwight here.)
Rather than focus on sales or earnings, our Unheard Of screen looks for lesser-known companies by searching for sparse analyst coverage. The idea is that, while analysts are useful for things like earnings estimates, the more of them that initiate positive opinions on a stock the higher its share price goes. So there are bargains to be had among stocks covered by just a few analysts. Houston-based department-store chain Stage Stores (STGS), for example, is up 26% since being featured in our Dec. 4, 2003, Unheard Of screen ("Staging a Comeback"), compared with a 2% rise for the S&P 500 index.
We used our stock screener recently to find some more near-anonymous but promising names. Searching through 8,200 stocks, we selected those with coverage by at least two but no more than four analysts. We then looked for things like rising earnings estimates, a history of upside earnings surprises and manageable debt. And PEG ratios for all of our screen survivors had to be less than 1.0. See the recipe to the right for all of our criteria. Our search turned up 28 companies. Let's take a closer look at one of them.
The semiconductor business is brisk right now thanks to increasing demand and rising prices. On Monday, we profiled Amkor Technology (AMKR), which handles outsourced packaging for major chip foundries (see "Hungry, Hungry Chippos"). Its shares are up five-fold since their September 2002 low, but thanks to skyrocketing earnings estimates and robust growth projections we still found the stock to have "one of the lowest PEGs we've written about."
While Amkor packages integrated circuits into useful arrays, Taiwan-based United Micro Electronics (UMC) makes semiconductors into integrated circuits. (These terms are thrown around loosely, but strictly speaking, semiconductors are used to make integrated circuits, which are in turn used to make chips, which become the brains of computers, cell phones, Shrek 2 Wise Crackin' Donkeys and more. Intel (INTC) is the world's leading chip maker, by far.) United's shares are up about 40% during the past year. Trailing-12-month sales totaled a whopping $2.6 billion. But sales for industry leader Taiwan Semiconductor Manufacturing (TSM) totaled a double-whopping-with-cheese $6.6 billion.
First-quarter results for United, reported on April 28, looked promising. Sales grew 6.8% year-over-year and operating income jumped 27%. Earnings per American depositary receipt (a dollar-denominated, U.S.-traded share of a foreign company) of seven cents, vs. a penny a year ago, topped analysts' expectations by two cents. Kevin Vassily, a semiconductor analyst with Bala Cynwyd, Pa.-based research firm Susquehanna Financial Group, called the results "strong" in an April 29 note and observed that "higher pricing and an improved product mix offset capacity constraints." As with Amkor, United's strong results are in large part a result of those jazzy new cell phones everyone's buying.
Vassily explains that in the semiconductor business, traditional wisdom holds that "you need to be either the technology leader," with higher selling prices and margins, or "an efficient provider of mature technology." United, he concedes, is neither. But he argues that while this may be a longer-term disadvantage, during the current demand upswing, "UMC's lower exposure to leading-edge business actually works as an advantage vs. [Taiwan Semi]." That's because United, in his view, has plenty of pricing improvements left to make as it shifts to a larger mix of leading-edge products — to 90-nanometer wafers from 130-nanometer ones, for example. (Vassily doesn't own shares of United; Susquehanna doesn't have an investment-banking relationship with the company.)
On a PEG basis, United's shares are cheaper than Taiwan Semi's, but just by a "1.26um2 SRAM Bit Cell," if that's as small as it sounds. United trades at 13.8 times 2004 earnings, and analysts project it will increase those earnings by 27.5% annually over the next five years. That gives the stock a PEG of just 0.50. Taiwan Semi's PEG is 0.55. The S&P 500 index's PEG is 1.54, according to Reuters Research.
Perhaps the reason United (along with most semiconductor companies) looks so cheap is that the industry has earned a reputation for boom-and-bust economic cycles. Investors may not have a great deal of confidence in analysts' growth numbers. But if we assume that United will meet analysts' projections for 2004 and increase earnings by just half of what the long-term projection calls for, that still puts its PEG at around 1.0, well cheaper than that of the broader market. If semiconductor analysts, then, are even semi-right, this No. 2 player could come up a winner.
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