<OT>Stock of the Day
Jan 17, 2000
Electro Scientific Industries: A Smart Chip Play
Senior Analyst: Luciano Siracusano (1/17/00)
One of the oldest adages on Wall Street is that the “trend is your friend.”
Big gains accrue to those who latch on to stocks that are cresting on powerful trends.
Electro Scientific (NASDAQ:ESIO - news) is one such company.
The company is part of the red-hot semiconductor capital equipment group. Stocks with exposure to semiconductor
manufacturers, including Electro Scientific, rallied on Friday in sympathy with Intel Corp. (NASDAQ:INTC - news) , which the
night before had blown out consensus fourth-quarter earnings estimates by nearly 10%.
Headquartered in Portland, Electro Scientific and its subsidiaries provide electronics manufacturers with equipment to produce
components used in wireless telecommunications, computers, automotive electronics and many other electronic products.
The company is also one of the leading suppliers of advanced laser systems used to improve the yield of semiconductor
memory devices, of high-speed test and termination equipment used in the high-volume production of miniature passive
electronic components, and of advanced laser systems used to fine tune electronic circuitry.
So why should you care?
Simply put, the chips and electronic components this company tests, improves and produces are going to be flooding your lives
in the next few years.
Ever more powerful microprocessors, which have transformed the personal computer, are going to be turning up in your
phones, cars, televisions, even your refrigerators.
The convergence of fiber optics, broadband, digital telecommunications and Internet telephony makes today's communications
revolution a bonanza for companies that help supply its building blocks. The chip industry, which has oscillated through global
peaks and valleys, is right now hitting on all cylinders.
Given the momentum behind all these varying technologies, the industry could have several years of rapid growth left in the
current cycle.
This is the bet that investors are making on Electro Scientific. In its second fiscal quarter, ended November, the company
earned $0.51 per share versus $0.19 a year ago. Total sales grew 36% to $66.9 million.
The report marked the fifth straight quarter that the company exceeded analysts' expectations.
That will probably continue this quarter, given the strength of the sector.
Right now, estimates for the May 2000 fiscal year call for the company to earn $2.35, versus $0.81 a year ago.
With Electronic Scientific closing Friday at $75, up $2.50, the stock's P/E is about 32 times May 2000 consensus earnings
estimates.
If we use an earnings estimate for calendar 2000 of $3.45, then the stock today is trading at about 22 times its forward P/E, or
about 13% of its forward calendar-year growth rate.
In other words, its PEG ratio (p/e divided by forward earnings growth rate) is just .13. It's rare to find a good growth stock in
today's heated market with a PEG rate of less than 1.0. Ideally, you want your good growth candidates to trade at a PEG ratio
of less than .5 and cyclicals to trade at less than a .25 PEG ratio.
By these measures, the stock stands up well, even with its recent run to record levels.
Electronic Scientific has another trend in its favor: The economic recovery now underway in Korea and Japan. Asian business
(excluding Japan) accounted for 53% of second-quarter sales, with sales to Japan accounting for another 20%.
Meanwhile, the company's largest business, capacitors (electronic components), which accounts for 34% of total revenue, has
also been growing the fastest, up 104% year-over-year in the November quarter.
Kyocera (NYSE:KYO - news) , the Japanese conglomerate with tentacles into nearly every area of Japan's high-tech
economy, is one of Electronic Scientific's largest customers. With Kyocera's recent acquisition of Qualcomm's
(NASDAQ:QCOM - news) handset business, it stands to reason that Electro Scientific's sales to the Japanese electronics
manufacturer will continue to show strong growth in the year ahead.
Electro Scientific sports a pristine balance sheet, with $51 million in cash and no debt.
With nearly fixed operating expenses, modest revenue increases will flow rather quickly to the bottom line, especially since the
company has only 13 million shares of stock outstanding.
The biggest risk for the company is, of course, that the cycle ends earlier than expected, or that rising interest rates snuff out
capital expansion at home and abroad.
Investors should know that just a few years ago analysts were very high on Electro Scientific.
In late 1997, the stock was trading at $60, and analysts were confident the company could earn $2.84 per share.
Then the Asian contagion spread to Korea, shaking financial markets and ripping up regional economies. Electro Scientific's
stock got hammered, falling below $20 less than a year later.
In short, this is a stock that you need to stay on top of … but one that we feel offers good potential.
Bottom Line:
We are confident that we are still in the early innings of the cyclical semiconductor boom and therefore believe this stock will
outperform the market over the next six to 12 months.
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