Adding Cohu To My Value Portfolio Watchlist (NASDAQ:COHU)

Today I’m introducing another potential candidate for my value portfolio: Cohu (NASDAQ:COHU).

Company

COHU is a provider of test equipment and services operating essentially worldwide. Among other things, it provides semi-conductor test and inspection handlers, MEMS test modules, thermally based test systems as well as automated equipment for wafer and device test and inspection. The following three slides from the most recent corporate presentation give a basic overview, including market share in various segments.

I will discuss the revenue and cash aspects below, but what I would highlight from the first slide is the 23,700 machines the company has installed; these are installations from which the company can generate recurring service revenues. In terms of company execution, I submit that the 26% CAGR on revenues over the past five years is also noteworthy.

In this second slide I’ll draw attention to the focus on profitability, the diverse customer base and the IP portfolio that acts as somewhat of a moat for the company.

Finally, and perhaps most importantly, is COHU’s market share which makes it a leader in several segments. In my admittedly anecdotal experience, leaders in their category are often targets of acquisition.

For anyone considering taking a position in the company, I highly recommend going through the entire corporate presentation as it does a good job of showing where the company believes its strengths lie and what its roadmap for the future looks like.

Financial Performance

As shown below, COHU has generally been increasing revenues and cash from operations, though there’s some distinct seasonality to its performance. As such, I prefer looking at the trailing twelve month chart shown in the second graph.

Indeed, COHU’s seasonality was highlighted during the most recent earnings call, with the company being more upbeat about the second half of the year (with my emphasis throughout).

We typically see seasonally low fourth and first quarter of the year. We are expecting sort of the same this year around Q1. Hard to predict right now, I’m going to peg it at somewhere between 3% to 5% down sequentially from Q4, which is generally in line, I think, with what we’ve been saying.

Generally speaking, sort of a softer half of the year, like we talked earlier as well a quarter ago, mostly because of the way the markets are in consumer and mobility, also PCs. And then we’re forecasting more of a pickup in the second half of the year. We do have already some orders on the books for Q2, Q3 delivery related to mobility market process for test actually.

We do have some strong forecast now for the server market ramping in the second half of the year, much stronger than the first half. As I said in the prior call — in the prior question, sorry, expect industrial and automotive to be strong next year, probably also stronger in the second half as that continues to grow.

But not only is this industry seasonal, it is also cyclical with potentially steep bull and bear markets. Thus COHU is hyper focused on recurring revenue to help mitigate some of this cyclical volatility. And there is substantial progress on this front as discussed on the earnings call.

Cohu’s significant recurring business has produced a three-year compound annual growth rate of 6.5% and represented approximately 42% of third quarter revenue at 54% non-GAAP gross margin. In the last four quarters, recurring was $336 million or 41% of sales, delivering a profitable and resilient revenue stream through industry cycles. Our recurring revenue is primarily made up of test contactors and device application kits that are mainly IC design-driven and benefit from the introduction of new semiconductor products by our customers.

The balance were approximately 43% of our recurring over the last 12 months comes from service revenue across 280 customers manufacturing facilities in 31 countries. Our service business unit manages a large volume of transactions through a cloud-based automated order management system, handling over 1 million parts shipments per year and provides on-site and remote assisted support to Cohu’s 23,700 equipment installed base.

This is not part of our customers’ capital budget, but a necessary operating investment to ensure continued semiconductor production. And as such, we have many customers engaged in support contracts with an annual renewal rate of more than 87% in the first half of 2022.

This aspect of the company is very important to me when considering COHU as a potential member of my value portfolio. I hope to manage/minimize volatility throughout the portfolio and this should help as it pertains to this particular stock.

Margins

The company also had positive comments regarding gross margins going forward:

[G]ross margin is steadily expanding with the transition of contactor manufacturing to our Philippines operation, ongoing progress to mitigate component shortages and lower costs, and development of differentiated products for test and inspection of silicon carbide, MEMS, ADAS and other advanced semiconductors.

Cash on Hand

In my opinion, having sufficient cash available is incredibly important for any company as it allows operational flexibility and the ability to take advantage of any special situations that may arise in its industry (particularly as it relates to potential M&A activity). As can be seen on the 3Q balance sheet, COHU has about $369M in cash and short term investments on its balance sheet. With approximately 47.7M shares outstanding, that’s $7.74 per share, or about 21% of the share price with the stock trading at $36.33. To me, this is a bullish factor for the stock.

Moreover, the company has just begun buying back shares, which could also help the stock price in the future.

Valuation

COHU’s current valuation metrics are shown in Seeking Alpha’s helpful summary table below. I’m particularly impressed by the EV/EBITDA numbers, but the overall B grade explains why I’m hoping for a bit of pullback in the stock price before acquiring my position. (I want to get the best possible entries for my long term value portfolio, even at the expense of missing out on some good opportunities if the stock price doesn’t pull back far enough.)

Quant Ratings

Seeking Alpha currently evaluates the stock as a “Strong Buy” with a 4.75 quant rating. Nonetheless most of the factor grades are in the “B” range, so I’m still hoping for a better buying opportunity (particularly given that we’ve had a big broad based stock market rally in January). Hopefully I’ll be given that opportunity.

Options

COHU trades options but they’re not particularly liquid. Nonetheless, for small accounts like mine, it should be possible to enter positions via writing naked puts and then to add some income via covered calls.

Risks

COHU operates in a very cyclical industry, and though it has taken steps to mitigate this risk, the risk is still very real. Moreover, the recent rally in semiconductor stocks may reverse, which would affect COHU along with all of its peers.

Trading Summary

I have added COHU to my “shopping list” with the hopes of buying shares if/when there is a dip in the share price. I’ve taken the deliberate risk of missing out on the stock if it doesn’t first pull back, but larger investors might consider taking a “starter” position at today’s stock price and then adding if the price falls.