Whenever investors’ eyes turn toward recovery, their eyes turn toward semiconductors and semiconductor equipment companies as the tip of the spear. One of my favorites at these times is always Kulicke & Soffa (KLIC), which make chip assembly equipment. My recent recommendation was for buying the July $7.50 call options, and they are definitely clicking so far — up 38% so far, with more to go. And here’s why.
KLIC is one of the world’s leading makers of the tools that make semiconductors. Primary products include bonding tools and dicing blades. The company is growing fast in the economic recovery, and shares are cheap.
So what’s the big deal with semiconductor manufacturing tools? These companies’ shares always lead cyclical upswings because their products have to be purchased well before chip makers’ products are purchased. That reason is obvious, but here’s a cheap analogy: Before you make a peanut butter sandwich, you need to grow the peanuts, make the bread and forge the knife.
KLIC stock has been one of the great tech stories of the recovery, up over +600% since 2009 lows. Jumps from July 2009, February 2010 and May 2010 quickly exceeded prior highs each time.
During downswings in the economy, manufacturers of electronic products freak out and stop buying inventory — including semiconductors. Then when upswings start to get underway, they need to scramble like mad to order, and the chipmakers in turn scramble to buy new machinery.
This has broad implications because virtually every product that plugs into a wall in your home, outside of light bulbs, depends on a microchip as its brains. That includes things like dishwashers, which depend on analog chips to determine the heat of the water and length of soap and rinse cycles, as well as of course computers, cell phones and televisions.
KLIC’ expertise is in producing tools that attach minuscule wires within microchips, allowing their processing power to be exploited.
Founded in 1951, KLIC got its first break in 1956 when it created a bonder that connected tiny wires for Western Electric, the manufacturing arm of the predecessor of AT&T (T). That made KLIC one of the world’s first suppliers of semiconductor assembly equipment. Since then it has grown to log $440 million in annual sales with a broad suite of products built in manufacturing plants in the United States, Israel and China.
KLIC and other chip makers are now recovering from the 2008 recession, a time when the natural down cycle was made worse when big companies shunned Microsoft’s buggy new Vista operating system — a decision that aborted the traditional three-year PC upgrade cycle.
Now that IT managers have opened up their budgets again, and have embraced Microsoft’s new Windows 7 operating system, orders for new PCs are rolling again. And that has in turned led to a lot more chip buying — and of course orders for chip-making technology.
KLIC will be one of key beneficiaries of the upgrading process recovery. Sales jumped 510% last quarter and are expected to triple this fiscal year, albeit from a depressed base. Twice the size of its nearest assembly equipment competitor, KLIC has the largest market share in five of its six key products and supplies parts to large companies such as Texas Instruments (TXN).
One major risk facing KLIC is its lack of pricing power. The equipment assembly market is filled with companies that sell undifferentiated products. KLIC’s small customer base can easily switch to rivals, further pressuring prices during cyclical downturns. You can see this problem in the chart above where the stock nearly fell to $1 as sales plummeted during the recession before recently recovering.
Scott Kulicke, son of co-founder Frederick W. Kulicke Jr., has been chief executive since 1979. In recent years, he has reduced the firm’s cost structure by consolidating and moving operations to low-cost regions of the world and spinning off the unprofitable wafer-chip testing division. Management has also made two key acquisitions to enter faster-growing markets with the purchase of Alphasem in 2005 and Orthodyne Electronics Corporation in 2008.
Scott Kulicke noted that first quarter cash flow and profitability reflect ”unprecedented” demand for semiconductor assembly capacity. He said lead times have stretched five months into the fall, giving “unusual visibility and the confidence to ramp up wire bonder production through this period.”
The consensus analyst estimate for 2010 and 2011 is $1.59 and $1.12, respectively. These both look a little bit low given KLIC’s current backlog. Even so, 2011 median estimates still value the stock at 7.2 times forward earnings, which is extremely cheap for a successful, fast-growing tech company. Hold the $7.50 July calls for a target north of $1.10.
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