Since the onset of the COVID-19 pandemic and the supply chain disruptions that came with it, the semiconductor industry has struggled to keep up with global demand for crucial chips.
Even today, lead times for some electronic components have been pushed into 2023. As a result, companies and governments have begun investing in expanding manufacturing capabilities to increase the supply of chips.
Naturally, investors are also searching for opportunities in the semiconductor market. One company that has caught the eyes of some investors recently is Cohu (NASDAQ:COHU). Valued at just $1.7 billion, this relatively small company may seem like an odd play on the massive semiconductor market.
Cohu is, however, one of the more interesting pick-and-shovel stocks for the industry. Here’s what you need to know about Cohu and whether the company is a buy.
Cohu Sells Shovels To Semiconductor Manufacturers
Cohu is the leading US manufacturer of test equipment for the semiconductor industry.
The company was started in 1945 and has long been engaged in making solid-state testing equipment for various electronic components. Cohu first went public in 1956. In the last few decades, its performance has been highly tied to that of the global semiconductor market.
Beyond this core business, Cohu also manufactures television and security camera equipment. Cohu is the parent company of Fisher Research Laboratories, which sells metal detectors and other underground detection equipment to the construction industry.
Cohu Revenue, Earnings & ROIC
Cohu’s Q3 2021 earnings report showed revenues of $225.1 million, up 49 percent from the same period in 2020.
Profitability was strong, with a gross margin of 42.3 percent. Non-GAAP EPS for 2021 rose to a total of $2.48. Importantly, the EPS reported for the first nine months of 2021 was more than double the full-year earnings for 2020.
One of the most impressive metrics highlighted in the Q3 report was the company’s return on invested capital. Previous guidance had suggested the return would be above 30 percent, already an impressive feat. Real performance, however, was 51 percent.
The report also shows Cohu sitting on an impressive cash stockpile. The company ended the quarter with a balance of $365 million on its balance sheets and a debt that had been reduced to only about $120 million. Free cash flow was also reasonably strong at 14 percent of revenues.
In 2021, Cohu initiated a $70 million stock buyback program. The program offset some share dilution and was meant to bolster confidence in the company’s future. That buyback, paired with its ongoing debt reduction, placed the company’s balance sheets in a very favorable position for Q4 and 2022.
Management Guidance
According to Cohu’s Q4 guidance, the company will bring in revenues of between $182 million and $195 million.
Further debt repayments of $1 million to $7 million were projected for the quarter. Management did, however, caution that Q4 would see somewhat lower performance due to seasonally low sales. Ongoing chip shortages could also prevent some of Cohu’s customers from investing in further testing equipment until Q1 2022.
Gross margin projections for Q4 are quite strong at 41 percent. The company’s eventual gross margin target is 45 percent, which it appears well-positioned to hit in the relatively near future.
Cohu Stock Price and Analyst Forecasts
Cohu shares have dropped significantly over the past year, with the 52-week high sitting at $51.86. The low for the year was $29.
Analyst price targets for Cohu are broadly positive and reflect the company’s significant potential to rebound as the semiconductor market continues to expand.
Out of 7 current ratings, the company has 6 buys and 1 sell. The average 12-month price target is $46.71. Critically, the lowest price target is $33.
With a low target just above the current trading price, even the most bearish analysis suggests that there is little room for Cohu to slide lower over the next 12 months.
Is Cohu a Good Buy?
Looking at the earnings report, there’s a great deal to like about Cohu at the moment. The company is profitable, flush with cash and gradually paring down its debt load.
Very strong revenue growth in 2021 and an excellent return on invested capital also support a positive outlook for Cohu going forward.
Cohu seems to be in a good position to grow well for at least the next few years. At this point, it’s reasonably safe to assume a strong growth trajectory through at least 2025 that would substantially increase the company’s overall value.
The push for more semiconductor manufacturing clearly isn’t a transient phenomenon, and few companies are in a position to compete with Cohu when it comes to providing the testing equipment needed to support that manufacturing.
As the market for chips continues to work toward meeting demand and guarding against supply chain issues, Cohu will be an obvious beneficiary. While backlogs could keep some of its orders from coming through until later in 2022, the company will continue to have an extremely strong market for its products.
Financial Multiples Attractive
Cohu also has a price-to-earnings ratio of just 9.7. With the current P/E ratio of the S&P 500 holding at about 25, this low ratio raises the possibility that the stock could be slightly undervalued. The forward P/E ratio is somewhat higher at 11.75. Even this, however, makes Cohu look like a good value if the company can continue to produce strong growth.
Another factor to consider about Cohu is its ongoing push to improve margins while keeping costs under control. As noted above, the company’s eventual gross margin target is 45 percent.
International Expansion
One of the most critical moves the company is making toward this goal is expanding its manufacturing presence in the Philippines. As this trend continues, it appears that Cohu should be able to continue raising its margins into the second half of 2022.
Cohu could even stand to benefit from government efforts in the drive to build more semiconductor manufacturing outside of the Asian market. At the moment, both the US and Europe are exploring policies to promote more chip facilities within their domestic markets.
Governments around the world are pouring money into the semiconductor industry in hopes of resolving global chip shortages and preventing strategic dependence on third-party countries. As a supplier of testing equipment, Cohu is in a very good position to capitalize on this trend as new facilities spring up.
5G Tailwind
A final piece of good news for Cohu in the immediate future could be the transition toward 5G communications networks. In the question and answer section of the Q3 earnings call, management detailed a demand ramp for testing of 5G phone components.
At present, testing equipment is needed to support the rollout of an estimated 250 million 5G phones in 2022. As 5G technology rolls out and increases the demand for high-performance semiconductor components, Cohu will likely see more demand for its products.
Debt Is A Burden
Despite its obvious appeal, Cohu isn’t without its risks. The company does have a fairly large amount of debt. However, it also has enough cash to cover its obligations under just about any foreseeable circumstances.
The debt also carries relatively low interest rates that don’t seem to be eating into the company’s bottom line appreciably. According to Q4 guidance, for example, Cohu will only spend about $900,000 in the quarter on interest expenses.
Concentration of revenue in large customers could also be somewhat worrisome. The Q3 earnings report mentions two large automotive customers each accounting for more than 10 percent of Cohu’s total sales. With more than 20 percent of revenues dependent on just two customers in the same industry, Cohu could be hit hard by a downturn in the automotive market. With that said, such a downturn seems unlikely in the near future.
There’s also a possibility that Cohu’s current performance could be short-lived. Chip shortages associated with the COVID-19 pandemic have obviously favored the company and allowed it to achieve high levels of growth. Prior to that development, however, Cohu struggled with profitability. The last profitable year for the company before 2021 was 2017.
Cohu Stock Forecast: Buy or Sell?
At the moment, Cohu is a reasonably priced company with natural exposure to a market that is pushing toward rapid expansion. The company is positioned to profit from important new technologies, including 5G. It also holds more than enough cash to invest in new R&D or expanded production as needed.
Provided semiconductor companies and governments continue to invest in new production over the next few years, there’s very good reason to believe that Cohu will continue to see high levels of growth. Because it is actively working to increase its margin rates, this growth should be expected to deliver satisfying profits in the years to come.
The company’s debts and concentration in the automotive sector present minor concerns. However, both of these issues seem to be well under control and likely don’t expose Cohu to too much near-term risk. On balance, the advantages of Cohu stock seem to strongly outweigh the disadvantages.
Overall, Cohu seems like a strong potential buy for investors looking to take advantage of the semiconductor market’s expansion. While Cohu likely can’t sustain its current trajectory indefinitely, there are good reasons to believe that its growth will remain strong through the middle of this decade.
Because it doesn’t suffer from the widespread problem of overvaluation, Cohu has strong potential for more conservative value investors as well as those chasing high-growth stocks.
At the time of research, the upside potential to fair market value per share for Cohu was 34%, representing a rise to $43.78 per share.
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