Is Kulicke and Soffa Industries Inc. Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Kulicke and Soffa Industries (NASDAQ: KLIC  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Kulicke and Soffa's story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Kulicke and Soffa's key statistics:

KLIC Total Return Price Chart

KLIC Total Return Price data by YCharts

Passing Criteria

3-Year* Change 

Grade

Revenue growth > 30%

(39.2%)

Fail

Improving profit margin

(42.9%)

Fail

Free cash flow growth > Net income growth

(31.3%) vs. (65.3%)

Pass

Improving EPS

(66.8%)

Fail

Stock growth (+ 15%) < EPS growth

51.4% vs. (66.8%)

Fail

Source: YCharts. * Period begins at end of Q1 2011.

KLIC Return on Equity (TTM) Chart

KLIC Return on Equity (TTM) data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

(84.9%)

Fail

Declining debt to equity

No debt.

Pass

Source: YCharts. * Period begins at end of Q1 2011.

How we got here and where we're going
Kulicke and Soffa has been in a veritable freefall over the past three years, with its only genuinely positive moves coming from its elimination of all debt burdens two years ago and in its share price. The company's two out of seven passing grades contains one technicality, as free cash flow merely declined at a slower rate than net income. Despite this ongoing weakness, K&S has put together solid returns for shareholders, as its stock is up 50% even as its fundamentals deteriorate. Will investors notice this discrepancy and flee, or will K&S finally turn its sagging fortunes around and justify this inexplicable optimism? Let's dig a little deeper to find out.

Despite its ongoing fundamental decline, K&S has become somewhat of a darling of value investors of late. Earlier this month, B. Riley placed a Buy  rating on S&S shares with a $16.50 price target, representing upside of roughly 18% from current prices. K&S has also drawn attention from top-performing hedge fund management firm Lemelson  Capital Management, which has built an activist stake in the company and which in April published an open letter calling for an aggressive share buyback  program.

Lemelson's argument hinged on the assertion that K&S -- despite its ongoing fundamental deterioration -- is still a veritable cash machine, and an extremely undervalued one at that, since it carries so much cash on the balance sheet relative to its market cap. For comparison, let's look at K&S' cash-to-market-cap ratio (simply divide cash equivalents by market cap) as compared to several of its contemporaries in the tech-fabrication (primarily chips and LEDs) supply sector:

Company

Market Cap

Cash Equivalents

Cash-to-Cap Ratio

Kulicke and Soffa

$1.08 billion

$596 million

0.55

KLA-Tencor

$11.65 billion

$3.03 billion

0.26

Cree (NASDAQ: CREE  )

$5.91 billion

$1.22 billion

0.21

ChipMOS (NASDAQ: IMOS  )

$705 million

$415 million

0.59

Brooks Automation

$659 million

$136 million

0.21

Veeco Instruments

$1.37 billion

$482 million

0.35

United Microelectronics

$5.92 billion

$1.88 billion

0.32

Source: YCharts. 

As you can see, K&S stands out even in this highly cash-heavy sector for the sheer size of its war chest relative to its market cap. K&S also stands out in valuation terms, as it is currently the second-cheapest stock of this group and only one of two with a sub-20 P/E,  next to only ChipMOS and its P/E of 16. In the past five years, this valuation has only increased by 16%, which shows a stock that is not easily swayed by short-term sentiments.

Additionally, it's worth considering that our three-year tracking period may underestimate K&S' ability to survive and thrive in a highly cyclical industry where spending (and thus revenue for supplier companies) moves in large waves over several years. This explains some, but not all, of the weakness seen in K&S' fundamentals -- over the past decade, K&S' revenue is still down by double digits, but net income is still twice as high as it was in 2004, even though it's suffered a pretty serious decline since 2011:

KLIC Revenue (TTM) Chart

KLIC Revenue (TTM) data by YCharts

All in all, K&S might not be a company at its brightest moment, but neither should it be counted out. At the very least, its massive war chest gives it incredible flexibility when it comes to improving its business, giving back to shareholders, or both.

Putting the pieces together
Today, Kulicke and Soffa has few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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