PSB Monthly Issue June 2010

| June 1, 2010

June 2010

PROFIT FROM SURGING GROWTH
IN COMPUTER SALES

I remember it like yesterday.  I was just 12 years old and my life was about to change forever.  I was so excited I could barely pay attention in school.

I’d been begging my parents for months about getting one.  I even made an elaborate presentation about all the terrific educational benefits.

Finally my parents gave in.

My dad brought it home after work.  He carried in a big white box with a multi-colored apple on the side.  I could barely contain my excitement.

Inside was a brand new Apple II+ computer.  At the time, this incredible machine wasthe pinnacle in home computing power.

Very few families had a personal computer (PC) in those days.  It was a brand new technology.  And many thought it was just a very expensive paper weight.

Thirty years later the PC has become an essential part of the home.  Ordinary people use them every day to perform a nearly infinite variety of tasks.

Still skeptical about the importance of computers?  Check out this factoid from market research firm, Gartner.  During the recent recession, “PCs remained the electronic device of choice on which to spend household income.”

This is a startling fact.

During the worst economic downturn since the Great Depression, consumers continued buying personal computers.  Clearly, the PC is not just a luxury item anymore.

Now the economy is starting to recover.  And PCs are entering a new multi-year growth cycle.

Gartner is forecasting worldwide PC shipments will jump 22% in 2010.  And they expect total spending on PCs will increase 12% to a whopping $254 billion!

Consumers should drive PC sales.  But business spending is expected to make a big comeback this year as well.

Here’s why.

Most companies were planning on upgrading their PCs in 2009.  But the recession forced many of them to hold off.  Remember, companies were focused on cutting expenses.

In 2010, that pent up demand is set to explode.

Businesses can’t afford to hold off on upgrading their aging PCs any longer.  And most businesses want systems running the latest operating system… Microsoft Windows 7.

Gartner expects business spending on PCs to increase 13% in 2010.

And here’s the best part.  Gartner sees the replacement cycle starting in the second half of 2010, picking up pace in 2011, and lasting through 2012.

All of this adds up to one thing… PC manufacturers and their suppliers are poised to enjoy several years of strong growth.

One penny stock is perfectly positioned to cash in on this trend.  This amazing company supplies critical components used in PCs and other electronic devices. IntroducingSmart Modular Technologies (NASDAQ: SMOD).

 

Key Investment Data

Name:  SMART Modular Technologies
Ticker Symbol:  SMOD
Market Cap:  $383 million
Recent Price:  $6.14PSB Rating System 4.8 Stars

Raging Revenue:  (5.0 stars) Revenue is expected to rocket 47% higher this year.  A major PC upgrade cycle should drive strong demand for products containing the company’s technology.

Beautiful Books:  (5.0 stars) Management is forecasting earnings growth of 1,500% this year and 30% next year.  Plus, the company has lots of cash, adequate liquidity, and low debt.

Stellar Structure:  (4.5 stars) Given the size of this company, insider ownership of 5% is meaningful.  And institutional ownership of 86% shows the smart money loves this company.

Valuation Verification:  (4.7 stars) The stock is badly 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 88% or more.

Meaningful Milestones:  (4.7 stars) The company has beaten analysts’ earnings estimates in six straight quarters.  A good sign management’s guidance is conservative.  We should see more upside surprises going forward.

Let’s take a closer look at what this exciting company does.

THE COMPUTER MEMORY BUSINESS

SMOD is a leading manufacturer of memory modules, solid state storage products, and thin film transistor liquid crystal displays (TFT-LCD).  The company’s technology is incorporated into a wide variety of electronic devices.  These include PCs, notebooks, servers, routers, storage systems, printers, and gaming machines to name a few.

With consumers and businesses poised to increase spending on PCs, SMOD is on the verge of a major new growth cycle.

Every PC has memory modules inside.  They’re critical for PCs to do all the neat stuff they do.  As demand for PCs increases, SMOD is certain to sell quite a few more memory modules.

Moreover, higher PC sales usually drive higher sales of other products.

For example, when a consumer buys a new PC, they often buy a new flat screen (TFT-LCD) monitor and a printer too.  Prices for both products have come down significantly. And many stores sell them as part of a package deal with new PCs.

Likewise, many businesses will purchase new flat screens and printers along with new PCs. It makes sense to upgrade systems at the same time.  And they can negotiate better deals on larger orders.

But that’s not all.

Businesses are certain to buy other hardware too.  Many will upgrade networks with faster servers and routers.  And a number of businesses will add new storage capacity.

Here’s the key.

A good number of these products will have SMOD chips inside.  And sales of these products will provide an additional boost to the company’s revenue growth.

Now the markets SMOD competes in are highly competitive.  But don’t worry about the company’s ability to compete.  SMOD is right in the center of this growth cycle.

SMOD markets their products to over 400 major original equipment manufacturers.

Top customers, Hewlett Packard and Dell, stand to sell millions of new PCs, notebooks, flat screens, and printers during this new cycle.  And another major customer, Cisco Systems, is sure to sell tons of networking gear.  With customers like these, SMOD is sure to see strong revenue and earnings growth throughout this cycle.

In fact, the company is already starting to see a positive impact on their financials. Let’s take a peek at them now.

THE NUMBERS

SMOD recently reported another quarter of accelerating growth.

In the second quarter, revenue jumped 47% year over year to $160.1 million.  More importantly, revenue increased 30% from the first quarter’s figure.  A clear sign demand for the company’s products is rising.

Best of all, profitability is increasing as well.

Net income soared 250% over the first quarter’s number to $16.1 million.  Earnings more than tripled to $0.25 per share.  And the company handily beat analysts’ estimates of $0.14 per share.

As a result of this surging growth, analysts are scrambling to raise estimatesacross the board.

For fiscal year 2010 (ending in August), they’re now forecasting revenue of $649 million and earnings of $0.64 a share.  That’s year over year growth of 47% and 1,500% respectively.

For fiscal year 2011, analysts are forecasting revenue to increase 13.5% to $736 million.  And they’re expecting earnings will jump 30% to $0.83.

This is great for SMOD shareholders.

Remember, rising revenue and earnings estimates tend to drive a stock’s price higher. Plus, given the speed at which SMOD’s growth is accelerating, I think there’s further upside to these forecasts.

In addition to strong growth, SMOD also sports a strong balance sheet.

The company’s sitting on over $118 million in cash.  Liquidity is adequate with current assets 2.8x greater than current liabilities.  And total debt is very manageable at just $55 million.

INVESTMENT RISKS

Of course, an investment in SMOD does involve some risks.

The company’s growth depends on the economic recovery and rising PC sales continuing.  Any disruption to these two events could derail SMOD’s growth cycle.

Another risk is high volatility in the prices of memory devices.  A surge in supply of memory devices could drive prices lower and impact SMOD’s profits.

A third risk is the company’s reliance on a few large customers.  The loss of one or more of these customers could hurt the company’s growth.

POTENTIAL RETURNS OF 88% OR MORE

SMOD shares are poised for huge gains over the next year.

The economic recovery and PC upgrade cycle are spurring heavy demand for the company’s products.  Thanks to a strong balance sheet and appropriate leverage, SMOD is growing net income and earnings at a rapid rate.

As revenue and earnings continue growing quarter by quarter, we should see SMOD shares move significantly higher from here.

Amazingly, the shares are badly mispriced by the market.

Right now SMOD is trading at just 9.6x the 2010 estimate of $0.64 a share.  That’s a low P/E for a company expected to grow earnings 18% a year over the next five years.

In fact, with a PEG ratio of just 0.55, SMOD is trading at a 45% discount to their projected growth rate.

Given the macro and micro growth drivers, I think SMOD deserves a P/E at least equal to their projected growth rate.  At 18x the 2010 estimate, the shares are worth $11.52. That’s upside potential of 88% or more!

And if we look ahead to next fiscal year, the shares are poised for even bigger gains. At 18x the 2011 estimate of $0.83, the shares are worth at least $14.94.  That’s a whopping 143% higher than the stock’s recent price.

Based on my analysis, I expect the shares to trade up to at least $11.00 per share.  Buy SMOD now for potential gains of 88% or more.

ACTION RECOMMENDATION

BUY SMART Modular Technologies (NASDAQ: SMOD) up to $6.88 per share.

Recent price is $6.14.

Use a stop-loss of $3.44 on this position.

Don’t forget your position sizing and stop-loss rules.

 

smod052810


BIG GAINS AHEAD FOR THIS
TINY COMPANY WITH HUGE TECHNOLOGY

Our second pick this month is a return to one of our favorite investment themes… the emerging boom in chip equipment manufacturing.  You might recall we introduced this theme in our March Issue.

Why are we crazy about chip equipment makers?

That’s easy.  The early stages of chip equipment growth cycles have been great for shareholders in the past.  It’s not uncommon for many of these stocks to double or even triple in value during a new growth phase.

And this new growth cycle is shaping up to be a doozy.

The outlook for the industry over the next two years is fantastic.  SEMI, the industry’s trade association, is forecasting chip equipment sales growth of 53% in 2010 and 28% in 2011.

And recent data show the growth cycle is gathering momentum.

April bookings (new orders) increased 8.1% from March to $1.44 billion.  Bookings are now at their highest level since June 2007.  And more importantly, bookings have increased for six straight months.

Sequential increases like this are a clear sign growth is accelerating.

April billings (orders shipped) were even better.  They jumped 16% from March to $1.28 billion.  This marks the biggest increase in nine months and the highest level since May 2008.  Billings have now increased twelve months in a row.

Best of all, the book to bill ratio stayed above 1.0 for the tenth straight month.

The book to bill ratio is a simple but effective way to measure demand in the chip equipment market.  A reading above 1.0 means more orders are coming in than are being shipped out.  In other words, it means the industry is growing.

The trend in the book to bill ratio is the strongest evidence yet of a sustained recovery in the chip sector.

After much research, we’ve found a tiny chip equipment maker experiencing explosive growth.  This amazing company is carving out a nice niche for itself with new chip manufacturing technology.

The company is none other than Nova Measuring Instruments (NASDAQ: NVMI). Let’s take a closer look at the company’s remarkable technology.

 

Key Investment Data

Name:  Nova Measuring Instruments
Ticker Symbol:  NVMI
Market Cap:  $98 million
Recent Price:  $4.34PSB Rating System 4.8 Stars

Raging Revenue:  (5.0 stars) Revenue is expected to jump 64% to $64 million.  The company’s disruptive technology and an industry wide growth cycle should drive the increase.

Beautiful Books:  (5.0 stars) Earnings are expected to soar 208% to $0.40 in 2010 and 25% to $.50 in 2011.  Plus the company has a strong balance sheet with $40 million in cash and no long term debt.

Stellar Structure:  (5.0 stars) Insiders are clearly confident with ownership at 28%.  And the company has unusually strong institutional support at 31% ownership.

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 $7.80 a share.  That’s upside potential of 80% or more.

Meaningful Milestones:  (4.7 stars) The company posted its first profit in nine years in 2009.  And the company has strung together three straight profitable quarters.  This trend clearly points to more growth ahead.

THE METROLOGY SYSTEMS BUSINESS

NVMI is a leading manufacturer of metrology systems used in the semiconductor manufacturing process.  While the company’s tiny (market cap of just $98 million), their technology is huge.  Last year, NVMI’s metrology systems were being used by 15 of the 20 chip makers with the highest capital spending.

I’ll explain why the company’s technology is so popular in a moment.

First let me briefly explain what a metrology system is.

Metrology systems measure various thin film properties and critical circuit dimensions during various steps in the manufacturing process.  I know it sounds complicated.

Here’s the key point to understand.

Metrology systems give chip makers multiple opportunities to adjust the manufacturing process at critical times.  These adjustments can increase quality, productivity, and yields. In other words, metrology systems can provide a big boost where it counts the most… the bottom line!

Lots of companies make metrology systems. What makes NVMI’s system so great?

NVMI’s system can be integrated directly inside many types of semiconductor manufacturing equipment.  This provides several important advantages. I’ll get to them in a moment.

Before NVMI’s technology, chip makers used only stand-alone metrology systems.  The problem with these systems… they interrupt the manufacturing process.

The silicon wafer must be physically removed from the process machine and placed on the measuring or inspection tool.  This step is repeated several times during the manufacturing process.  It’s an inefficient step costing valuable time and money.

NVMI’s technology resolves this problem.

Their metrology system uses optical measuring systems small enough to be integrated inside the manufacturing equipment.  No longer do chip makers have to move the wafer to a separate machine for measuring and inspection.

NVMI’s integrated systems enables chip makers to reduce costs and increase production efficiency, yields, and quality.

With global demand for semiconductors rising sharply, the chip equipment industry is entering a new multi-year growth cycle.  Chip makers are investing in new manufacturing equipment to increase production capacity.  It’s the only way to keep up with demand.

And you better believe they’ll be looking closely at equipment that can boost productivity and cut costs.

NVMI’s metrology systems clearly fit the bill.  In fact, we’re already seeing signs of a new growth trend in the company’s financials.  Keep reading for the details.

THE NUMBERS

NVMI is on a roll.  The company has earned a profit in three straight quarters.  And they just completed their first profitable year in almost a decade.  It sure looks like the beginning of a new growth trend.

2009 was a watershed year for NVMI.

The company actually grew revenue in a year when the industry shrank by 50%.  Gross margins expanded from 33% to an impressive 45%.  And they posted a profit of $2.6 million or $0.13 per share.  Credit the results to market share gains and sound cost-cutting.

Best of all, we’re seeing growth continue in 2010.

In the first quarter, revenue soared 179% year over year to $16 million.  Record high shipment levels drove the increase.

Gross margins expanded to 51%.  Net income increased from last year’s loss to $2.7 million.  And earnings improved from a loss last year to a profit of $0.11 per share.

A great quarter all the way around.

And management boosted guidance for 2010 to boot.  They’re now expecting revenue of $61 to $66 million.  That’s an increase of 55% to 68% over last year’s figure!

The improved guidance sent analysts’ estimates higher across the board.  They’re now forecasting a revenue surge of 64% to $64 million.  And they’re expecting earnings to soar 208% to $0.40 a share.

In addition to skyrocketing growth, NVMI has a strong balance sheet.

They’re sitting on a cash hoard of $40 million or $1.77 per share.  The company has ample liquidity with current assets 4.2x current liabilities.  And they have no long-term debt.

INVESTMENT RISKS

Like any investment, NVMI does involve some risks.

The positive outlook for NVMI depends on recovery in the global economy and the chip industry continuing.  A slip back into recession would likely hurt future results.

Another risk is the company’s dependence on just two product lines.  Any drop in demand or prices for these products would hurt the company’s business.

A third risk is the company’s reliance on a small number of large customers for a big portion of sales.  The loss of one or more of these customers could cause business to suffer.

POTENTIAL RETURNS OF 80% OR MORE

NVMI is poised for big gains in 2010 and beyond.

The semiconductor industry is just beginning a multi-year growth phase.  As a result, chip makers are investing huge sums in manufacturing equipment.  They need to boost production capacity to keep up with rising demand.

And NVMI has a new technology that can directly boost the bottom line.  Talk about perfect timing!

Despite a strong growth outlook, NVMI’s shares are mispriced by the market.

At a recent price of $4.34, the shares are trading at just 8.7x the 2011 estimate of $0.50 per share.  That’s well below the industry average of 15.6x.

Given the company’s much higher than average growth rate, they deserve a P/E at least equal to the industry average.  At 15.6x the 2011 estimate, NVMI is worth at least $7.80 a share.

Based on our analysis, we see the stock trading up to at least $7.80.  Buy
NVMI now for potential gains of 80% or more.

ACTION RECOMMENDATION

BUY Nova Measuring Instruments (NASDAQ: NVMI) up to $5.00 per share.

Recent price is $4.34.

Use a stop-loss of $2.17 on this position.

Don’t forget your position sizing and stop-loss rules.

 

nvmi052810


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