Thursday, January 31, 2013

With Strong Fundamentals, This Semiconductor is So Cheap

Cash flow is an important indicator of business operation efficiency, and it is more reliable than earnings in terms of valuing a business, as it is less manipulated. Free cash flow is the amount of cash available to the company after all necessary capital expenditures. Thus, I would be quite excited with companies trading at low Price/Free Cash Flow ratio. In addition, if the cash flow was generated without the help of high leverage and it delivered a high return on invested capital, it could be a low risk/high reward opportunity. Here is one company, with the market capitalization of larger than $500 million, that fits those three criteria: Kulicke & Soffa Industries (NASDAQ: KLIC).
Business Snapshot 
Kulicke & Soffa (K&S), incorporated in 1956, is an equipment and expendable tools provider for semiconductor device manufacturers, test providers, and other electronic manufacturers. The majority of its revenue ($727 million) was from the Equipment segment, accounting for nearly 92% of the company's total revenue. In fiscal 2012, around 98.3% of the total sales were to customer locations outside of the US.
Cash Cow with High Return
K&S experienced operating losses in 2008 and 2009 due to the negative impact of the global economic downturn. Its revenue was very low during those two years dropping from $700 million in 2007 to only $328 million in 2008, and to only $225 million in 2009. However, in 2010, sales bounced back to $763 million. Since then, K&S has consistently delivered a high return on invested capital, from 25.62% to 38.76%. In fiscal 2012, the return on invested capital was 26.35%, whereas the return on equity was 28.84%. During the same three-year period, K&S generated consistently positive operating and free cash flow. It generated $182 million in operating cash flow and $161 million in free cash flow in fiscal 2012.
Market Leader in its Products
Interestingly, in the boring semiconductor industry, K&S held the #1 position in many of its product markets, including Wire Bond, Wedge Bond, Stud Bump, and Capillaries. In 2012, it was reported to have 70% of the Wire Bond market. In the company’s recent presentation, it said that the market research forecasted that 83% of all Integrated Circuits would be Wire Bonded in 2016.  
Source: K&S Presentation
Cash Cow but Cheaply Valued
To achieve high return on invested capital, K&S employed no leverage at all. As of September 2012, it had $744 million in stockholders’ equity, no debt, and $440 million in cash. Thus, with the total market capitalization of $871.34 million, the enterprise value is much lower, at only $431 million. So the market values K&S at only 2.68x P/FCF. Its EV/EBITDA is also quite low, of 2.17x.
Among its peers, including BE Semiconductor (NASDAQOTH: BESIY) and Teradyne(NYSE: TER), K&S had the lowest valuation among the three. As mentioned above, K&S is valued at 2.17x EV/EBITDA and 5.4x P/E, whereas BE is valued at 4.89x EV/EBITDA and 11.5x P/E. The market is valuing Teradyne at a slightly higher EV multiples, at 5.15x and 10.2x P/E.
Foolish Bottom Line
It is good to see K&S had a market leader position in its Wire Bond product, along with the potential growth of its semiconductor niche. With the debt-free operation, high return on invested capital, low free cash flow, and EV multiples valuation, K&S is definitely a great value pick for investors.

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