PSB Monthly Issue August 2010
August 2010
LIFTS ALL BOATS!
“The trend is your friend.”
This simple saying is one of the most famous bits of Wall Street wisdom. Great investors and top money managers often repeat it.
And investors who fail to heed this warning do so at their own peril.
Of course there are many different kinds of trends. You have broad market trends, economic trends, and industry trends just to name a few. Investing with these trends is key to racking up profits in the market.
Today I’m focusing on a particular industry trend.
When I find powerful industry trends, I like to play them to the hilt. I’ve found you can pocket big profits by riding solid industry trends. And that’s exactly what we’re going to do with this recommendation.
We’re going back to the well one more time.
A strong trend I identified back in March is gaining steam. Experts on a certain industry are cranking already high growth rates even higher.
If you’re thinking chip equipment makers, give yourself a pat on the back.
The industry is growing much faster than anyone expected. In March, the industry’s trade association projected chip equipment sales growth of 53% for 2010. However, in July, the association boosted their forecast by a wide margin.
They’re now forecasting chip equipment sales will soar 104% this year!
It seems pent up demand is bigger than anyone suspected. Remember, spending on chip equipment plunged in 2008 and 2009. Chip makers essentially stopped buying manufacturing equipment during the economic recession.
With the economy recovering, demand for computers, smartphones, flat-screens, printers, and other electronics is soaring. And every one of these devices uses semiconductors.
As a result, demand for semiconductors is going through the roof.
With demand for chips exploding, chip makers are rushing to expand manufacturing capacity. They’re buying all the chip manufacturing equipment they can get their hands on.
This buying frenzy is creating a bonanza for chip equipment makers.
They’re seeing revenue and earnings growth jump quarter by quarter. A number of them are blowing away analysts’ estimates. And analysts are scurrying to raise estimates to keep up with reality.
But here’s the best part…
Thanks to the market correction, several penny-sized chip equipment manufacturers are trading at bargain prices. We have a rare opportunity to grab a turbocharged chip equipment maker at a hefty discount.
One of these companies is FSI International (NASDAQ: FSII).
Name: FSI International Ticker Symbol: FSII Market Cap: $136 million Recent Price: $3.54 PSB Rating System 4.9 Stars Raging Revenue: (5.0 stars) Revenue growth is red hot. Revenue is expected to surge 81% in 2010 and 37% in 2011. A stronger economic recovery could boost the 2011 figure even higher. Beautiful Books: (5.0 stars) Earnings are expected to surge into positive territory in 2010. And they’re expected to soar 80% in 2011. Balance sheet is iron clad with $12 million in cash and no long-term debt. Stellar Structure: (4.6 stars) Insider ownership is very low at less than 1%. However, one insider just bought 600,000 shares at $3.05. Institutional ownership is a robust 46%. But there’s still plenty of room for it to expand. Valuation Verification: (4.7 stars) The stock is mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $9.10 a share. That’s upside potential of 157% or more. Meaningful Milestones: (4.7 stars) The company has posted higher revenue and earnings in three straight quarters. |
According to my research, FSII is one of the fastest growing chip equipment makers around. And, they’re also one of the most badly mispriced.
Keep reading for the lowdown on this exciting company.
THE CHIP EQUIPMENT BUSINESS
FSII provides surface conditioning technology and microlithography systems to manufacturers of integrated circuits. They do business all over the world including North America, Europe, and Asia.
The company’s no newcomer to the chip equipment business.
They’ve been supplying equipment to the world’s biggest chip makers for over 37 years. The company’s top customers are industry heavyweights Samsung, ST Microelectronics, and Intel.
Why is FSII so successful? I’ll show you exactly why in a moment. But first you have to understand the problem the company helps customers solve.
You see, the manufacturing process for integrated circuits is very complex.
It all starts with preparing the surface of the silicon wafer. The surface preparation phase includes more than 100 steps. As you can imagine, many factors are considered when designing a surface preparation process.
No single surface preparation process is optimal for every job.
Now we’re getting to why the big boys choose FSII…
FSII understands the surface preparation process must be optimized to achieve the customer’s goals. They offer a range of different surface cleaning technologies. And they work directly with customers to design the perfect solution for each step in the cleaning process.
But having a broad product line is just one key to success. The other is maintaining low operating costs. And once again, FSII is ahead of the curve.
The company used the downturn in 2008 and 2009 to cut costs dramatically. They implemented several different cost reduction initiatives. And these initiatives have chopped quarterly operating expenses to the bone.
More importantly, the cuts have lowered FSII’s breakeven revenue level.
Now FSII has a streamlined operation with huge profit leverage. This puts them in perfect position to cash in on the recovery in chip equipment. And that’s exactly what they’re doing…
THE NUMBERS
FSII is knocking the cover off the ball in 2010.
Check out these terrific nine month results.
Revenue surged 71% to $62.2 million. Net income jumped from a loss of $17.6 million to a profit of $6.4 million. And, earnings climbed from a loss of $0.57 to a profit of $0.20 per share.
That’s a huge turnaround from last year.
Even better, revenue and earnings have grown sequentially from quarter to quarter. Steady quarterly increases show the company’s recovery is accelerating.
And the outlook going forward is… high-velocity growth!
Fiscal year 2010 (ending in August) is a major turning point. Revenue is expected to skyrocket 81% to $91.5 million. And earnings are forecasted to explode from a loss of $0.57 to a profit of $0.36 per share.
Talk about your turnarounds!
What’s more, stunning growth should persist into fiscal year 2011. Revenue is projected to surge 37% to $125.3 million. And earnings are expected to soar 80% to $0.65 per share.
If FSII can deliver on these expectations, the stock should move dramatically higher. Remember, nothing drives a stock higher than surging revenue and earnings.
But strong growth isn’t the only reason I like FSII.
The company also boasts a rock solid balance sheet.
They’ve stashed away a treasure trove of $12 million in cash. Short-term liquidity is robust with current assets 3.2x current liabilities. And, the company has no long-term debt.
INVESTMENT RISKS
Of course, an investment in FSII is not without risk.
The company’s strong growth outlook depends on the global economic recovery advancing. A slowdown could hurt their ability to expand.
Another risk is the company’s reliance on international sales. Fluctuations in currency exchange rates could dampen demand for FSII’s products.
A third risk is the company’s dependence on a few large customers for most of their sales. Losing one or more of these customers could hurt the business.
POTENTIAL GAINS OF 157% OR MORE
FSII is ready to rocket higher.
The ongoing recovery in the chip sector is driving strong sales of chip equipment. This trend is expected to last through 2011. As a result, FSII should see robust revenue and earnings growth through next year.
Despite this husky growth outlook, the shares are badly misvalued.
At a recent price of $3.54, the shares are trading at just 6.1x the 2011 earnings estimate. That’s well below the company’s projected long term growth rate of 20%.
Given the company’s outstanding growth outlook, I believe FSII deserves a PEG ratio at least equal to the industry average of 0.71.
A PEG ratio of 0.71 implies a P/E ratio of 14x for FSII. With a P/E of 14x, FSII would be worth $9.10 a share. That’s potential upside of a whopping 157%.
Based on our analysis, we see the stock trading up to at least $9.10. Buy FSII now for potential gains of 157% or more.
ACTION RECOMMENDATION
BUY FSI International (NASDAQ: FSII) up to $4.35 per share.
Recent price is $3.54.
Use a stop-loss of $1.77 on this position.
Don’t forget your position sizing and stop-loss rules.
BOOM IN NETWORKING EQUIPMENT
When you hear the word “internet”, what comes to mind? You probably think of the World Wide Web. Most people think these two terms mean the same thing.
But they really don’t.
The World Wide Web is just one of many services transmitted over the internet. It’s a way of accessing and sharing information over the medium of the internet. Of course, the web is the way most people use the internet.
In contrast, the internet is a global system of interconnected computer networks. It’s a network of networks. The internet is actually made up of millions of private, public, academic, business, and government networks.
Here’s the key point…
All of these different networks are linked together by a broad array of networking equipment. And at the heart of each piece of equipment you’ll find communications semiconductors.
Demand for these specialized chips is growing by leaps and bounds.
A surge in data traffic is tapping out the capacity of existing networks. And the ever-increasing need for more capacity is driving robust sales of networking equipment.
Why is more network capacity needed?
The number of internet users worldwide is exploding. Tens of millions gain access to the internet in developing countries every year. As the number of internet users grow, the drain on existing networks increases.
Another reason is the huge increase in internet traffic. Consumers and businesses are using higher bandwidth-intensive services like never before. Streaming audio and video, wireless data transfer, and voice over internet protocol (VoIP) just to name a few.
These services gobble up network capacity.
To keep up with demand, communication network capacity is expanding rapidly.
Telecom carriers, internet service providers, and cable operators are upgrading existing networks. They’re installing next generation equipment to provide voice, video, and data seamlessly over multiple networks.
In addition, service providers in developing countries are redoubling efforts to build-out telecom networks. Many networks were owned previously by government and require massive technological upgrades. And developing countries are rushing to complete 3G wireless networks.
All of these activities require tons of cutting edge network equipment containing… communications semiconductors.
The major global suppliers of networking equipment are familiar household names. Companies like Cisco Systems, Alcatel-Lucent, Nortel Networks, and Nokia. Of course, these are all huge companies.
However, there is a small, penny-size company that supplies components to these larger names. That company is none other than Mindspeed Technologies (NASDAQ: MSPD).
Name: Mindspeed Technologies Ticker Symbol: MSPD Market Cap: $222 million Recent Price: $7.07 PSB Rating System 4.6 Stars Raging Revenue: (4.5 stars) Strong demand for networking equipment is driving robust revenue growth. For FY 2010, revenue is expected to jump 35% to $171 million. Beautiful Books: (4.8 stars) Earnings are expected to rocket 255% to $0.70 per share in 2010. And estimates could be headed higher. Balance sheet is strong with $34 million in cash and just $13.7 million in long-term debt. Stellar Structure: (4.6 stars) For this size company, 6% insider ownership is fairly strong. Institutional ownership of 65% shows the smart money’s confidence is high. And institutions recently increased their holdings by 9.5%. Valuation Verification: (4.5 stars) The stock is mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $11.00 a share. That’s upside potential of 56% or more. Meaningful Milestones: (4.7 stars) The company’s posted a profit in two consecutive quarters. And they’ve beaten earnings estimates in four straight quarters. |
Let’s take a closer look at this fascinating penny stock…
THE COMMUNICATION SEMICONDUCTOR BUSINESS
MSPD provides semiconductors for communications applications in the wireline and wireless network infrastructure. They focus on three high growth areas… communications convergence processing, high performance analog, and wide area networking communications.
I know this sounds complicated. But you don’t need a PhD in network engineering to understand this company. All you really need to know is this…
Leading networking equipment manufacturers incorporate the company’s chips into a wide variety of products.
You’ll find MSPD’s chips in equipment designed to process, transmit, and switch traffic between different segments of a communications network. And, most importantly, the company’s chips handle voice, video, and data in seamless fashion.
Here’s what sets MSPD apart from the competition…
First of all, the company’s focusing on the fastest growing markets. Their products are geared for markets growing much faster than networking equipment in general. This focus drives higher growth rates than the industry average.
Second, the company has developed strong relationships with the leading manufacturers of networking equipment. These strong relationships help pave the way for early adoption of the company’s new products.
And, the company’s products are designed to work together for optimal performance. This helps drive sales. Customers save time and money by purchasing products with proven interoperability from a single supplier.
You don’t have to look very far to see MSPD’s strategy is working. The company’s financials tell the whole story.
THE NUMBERS
The global economic recovery is driving robust growth at MSPD. Take a look at the recent third quarter results.
Revenue surged 33% year over year to $43.3 million. Strong sales of high performance analog and wide area networking products drove the increase. More importantly, an 8% jump over second quarter revenue shows revenue growth is accelerating.
And that’s not all…
MSPD posted their second consecutive quarterly profit. Earnings popped 20% over the second quarter to $0.18 per share. What’s more, the number beat analysts’ estimates by the same percentage.
But here’s the best part…
Analysts are raising estimates across the board.
They now expect a revenue surge of 35% to $171 million, a massive improvement over last year’s 21% drop. And earnings are now expected to soar 255% to $0.70 per share. Much better than the week ago estimate of just $0.56.
Remember, rising estimates usually mean a higher stock price down the road.
But robust growth isn’t the only reason why I like MSPD. The company also sports a strong balance sheet.
They’re sitting on a cash hoard of $34 million. That works out to $1.08 in cash per share. Short term liquidity is great with current assets 2.8x current liabilities. And long term debt is very small at just $13.7 million.
INVESTMENT RISKS
Of course, an investment in MSPD does involve some risk.
The company’s new growth cycle depends on the global economic recovery continuing. If the recovery falters, MSPD could see slower growth.
Another risk is the company’s products are manufactured entirely by third-parties. If any of them experience manufacturing problems, MSPD’s growth could slow.
A third risk is the company’s reliance on overseas markets for most of their sales. A strong U.S. Dollar would make MSPD’s products more expensive which could hurt sales.
POTENTIAL GAINS OF 56% OR MORE
MSPD is poised for stellar gains.
Demand for the company’s chips is strong and growing. Revenue and earnings are increasing rapidly. Analysts’ estimates are moving steadily higher. And the company’s strong balance sheet will help weather any storms.
Despite all these positive factors, the shares are mispriced by the market.
At a recent price of $7.07, MSPD is trading at just 10x the 2010 earnings estimate. That’s well below the company’s projected earnings growth rate of 20%. In fact, the company’s PEG ratio is a low 0.51.
I believe the company’s robust growth will drive significant P/E expansion over the next year. If the economy keeps getting stronger, we could see the P/E swell to 20x… that’s equal to the projected growth rate.
With a P/E of 20x, the shares would be worth $14.00. That’s 98% higher than the recent price. I’d call that a best case scenario.
However, even if we use a more conservative P/E, the shares have hefty upside potential. With a P/E of 15x the 2010 estimate, MSPD would be worth $10.50. That’s 49% higher from here.
Based on my analysis, I see MSPD trading up to at least $11.00 per share. Buy MSPD now for potential gains of 56% or more.
ACTION RECOMMENDATION
BUY Mindspeed Technologies (NASDAQ: MSPD) up to $7.77 per share.
Recent price is $7.07.
Use a stop-loss of $3.50 on this position.
Don’t forget your position sizing and stop-loss rules.
Portfolio Update
- We recently issued a Sell Alert for Health Grades (NASDAQ: HGRD) on news they’re being acquired. Sell HGRD if you haven’t already and capture gains of 87% or more!
- We recommended selling China Pharma Holdings (AMEX: CPHI) in the last Portfolio Update. If you’re still holding CPHI, sell the shares now for gains of 26% or more!
- We’ve adjusted the buy price for MFA Financial (NYSE: MFA) to reflect the dividend of $0.19 per share paid on July 30, 2010.
- Move Nova Measuring Insturments (NASDAQ: NVMI) from Buy to Hold on price increase.
- Move Winner Medical Group (NASDAQ: WWIN) from Buy to Hold on price increase.
- Move GT Solar International (NASDAQ: SOLR) from Buy to Hold on price increase.
Category: PSB Monthly Issues
