Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Today we're going to take a look at a stock that doesn't get much attention on Wall Street -- and hasn't gotten a whole lot of attention here at The Motley Fool, either. Cohu, Inc. (COHU -1.68%) is its name, and making testing equipment for semiconductor chips is its game. And this morning, Cohu won a big endorsement from an analyst at DA Davidson, who says it's a buy.
Here's what you need to know.
DA Davidson lights up over Cohu's cheap share price. Image source: Getty Images.
Co-who?
As I mentioned, Cohu isn't much of a household name among investors -- on Wall Street or off. According to the data crunchers at S&P Global Market Intelligence, only a trio of analysts even follow Cohu stock (a small cap with a market value of less than $700 million), and only one of those analysts follows it closely enough to guess at a five-year growth rate.
So what is Cohu anyway?
More than a decade ago, Fool.com contributor Dan Bloom introduced us to this stock, advising that "Cohu makes testers for integrated circuits and counts Intel as one of its customers." Chipmakers like Intel charge more for faster-performing semiconductor chips, but first they have to test these chips to confirm they perform as advertised. "Cohu makes the equipment that performs these types of tests," wrote Bloom.
It's a pretty decent business, enabling Cohu to earn a respectable 12.6% operating profit margin on its $373 million in annual sales. Last quarter, Cohu grew these sales a modest 6%, and grew its profits nearly twice as fast -- all while paying its shareholders a tidy 1.1% dividend.
Upgrading Cohu
DA Davidson thinks Cohu can do even better than this in the future, though, as it explains in a write-up covered by StreetInsider.com (subscription required).
"Robust industry trends" in the semiconductor industry, argues Davidson, give this "leading provider of semiconductor test handlers and ... emerging player in the associated contactor and vision inspection markets" an "ample runway for growth." Cohu's also in the process of acquiring one of its top competitors, Xcerra Corporation (XCRA), in a deal slated to close next quarter, which will add scale to Cohu's business even as it removes a source of price competition.
At the same time, Davidson argues that at a valuation of only eight times 2019's expected earnings, Cohu stock is trading for about a 20% discount to the broader testing industry's average 10 times forward earnings valuation. In Davidson's opinion, this makes Cohu stock "severely undervalued." Predicting they will rally as much as 40% over the next year, the analyst says Cohu shares offer "one of the most attractive risk-reward profiles in the group today."
Valuing Cohu
Is DA Davidson right about that? I have to say that at first glance -- and maybe even second glance as well -- the numbers do look awfully tempting. Priced at just $628 million in market capitalization, Cohu boasts a (pre-merger) balance sheet overflowing with $142 million more cash than debt, giving the stock an enterprise value of just $486 million.
Weighed against the stock's $35.4 million in trailing earnings, that yields a debt-adjusted P/E ratio of just 13.7 for Cohu stock. Weighed against the company's $43 million in free cash flow, Cohu stock sells for an even more attractive enterprise value-to-FCF ratio of just 11.3.
Relative to the stock's 10% projected earnings growth rate and 1.1% dividend yield, that seems, at worst, a fair price. Given that Cohu actually grew earnings faster than 10% last quarter, and is likely to grow faster still after it absorbs Xcerra, the stock might even be cheap.
If I have one reservation about following DA Davidson into this stock, though, it's this: Back when we first started writing about Cohu in 2005, the stock was doing $231 million in annual revenue. Thirteen years later, Cohu's now doing $373 million in annual sales. That's an improvement to be sure -- but still, a mere 60% sales growth in 13 years isn't what most investors in tech sign up for. Additionally, I can't help but notice that 13 years ago, Xcerra was earning $34 million in net profits on its sales. Now, years its profits are all the way up to...$35.4 million, which works out to just 4% growth.
By all of which I mean to say that investors have bet on Cohu becoming a breakout stock before, and it hasn't worked out well. I think that before taking DA Davidson's advice, I'd like to wait a few quarters and see if Cohu's acquisition of Xcerra is really going to change the story very much.
