The semiconductor sector is very interesting right now. The industry appeared to be set for a big acceleration following the pandemic-related market turbulence. However, with fears of a recession looming, the sector has sold off due to its historically cyclical characteristics.
Yet in every cycle, the semi industry makes higher highs and higher lows. With the rapid growth of artificial-intelligence-based computing platforms, cloud computing, the Internet of Things, edge computing, and autonomous electric vehicles, semiconductor applications are broadening beyond just PCs and mobile phones. With increasing diversification, it's possible -- though not a certainty -- the semiconductor sector may perform better than expected in the next downturn. Meanwhile, several such stocks are already discounting the next drop.
The sector is also home to the cheapest stock in my portfolio.
Kulicke and Soffa is the cheapest in a cheap sector
Kulicke and Soffa Industries (KLIC -2.22%) is a leader in semiconductor packaging equipment across general semiconductors, leading-edge advanced packaging, electronics assembly, electric vehicle battery assembly, and mini/microLED display assembly.
K&S has a $2.54 billion market cap with $690 million in cash and no debt, good for a price-to-earnings (P/E) ratio of 5.5 and a remarkable 3.7 when backing out its excess cash. K&S also has dominant position in its core niche of wire bonding equipment, with roughly 60% market share, which should give it some modicum of pricing power to offset rising costs.
No doubt, Kulicke and Soffa's business is cyclical, and 2021 was definitely a "boom" year. Revenue was up 143% to $1.52 billion and earnings per share rose nearly 600% to $5.78. However, given the undersupply of semiconductors and the rapid digitization coming out of the pandemic, management sees 2022 slightly higher, at $1.58 billion in revenue, with even higher margins. So, it appears that Kulicke and Soffa will continue to generate similar or greater earnings and cash flow this year at least.
Recently, management decided to aggressively increase its share repurchases, with a $150 million accelerated repurchase program completed in April, which quickly retired nearly 4% of K&S' shares outstanding. With a healthy cash cushion, more profits coming in this year, and the share price now lower than the levels at which the stock repurchase happened, I'd expect continued buybacks.
Why Kulicke and Soffa is so cheap
Clearly, the market realizes that K&S is a highly cyclical stock. With talk of recession everywhere these days, it's no wonder K&S has sold off as investors anticipate a decline in revenue and profits -- if not this year, then in 2023 or 2024.
In past down cycles, Kulicke and Soffa's revenue typically declined from the previous peak by about 35% to 40%. In 2009, K&S' revenue fell 41% from the 2006 peak. In the 2013 trough, revenue fell 36% below the 2011 peak. And the 2019 trade war down cycle saw revenue decline 39% from the 2018 peak.
That sounds dire, but this downside already appears factored into the share price. If revenue were to decline 40% from this year's guidance of $1.58 billion, K&S would still make about $950 million in revenue. That's even higher than the previous peak, in 2018. Taking in the company's guidance for gross margin expansion to the low 50% range and the current level of operating expenses, K&S could still earn about $2.50 per share in a down-cycle trough. Given today's $43 share price and $11.50 in cash, that's only around 12 to 13 times trough earnings potential, when stripping out the excess cash.
How Kulicke could keep the up cycle going
The current acceleration of semiconductor demand could very well lead to multiple years at these high revenue and profit levels. Yet in addition, CEO Fusen Chen, who has been on the job since 2016, is cultivating multiple new growth drivers. These include advanced thermocompression bonding for leading-edge nodes, electric vehicle battery assembly, and equipment for mini/microLED screens. The miniLED sector could see massive growth over the coming years. With K&S just introducing its first miniLED product in 2019, total LED revenue already grew from $56 million in 2019 to $187 million last year, good for 14.3% of total equipment sales. Mini and microLED technology is new, and an improvement over traditional OLED screens. They are only in a few highly advanced displays currently -- most notably last year's iPad Pro, as well some high-end televisions; however, as the technology becomes more mature, advanced displays could find their way into more mass market PCs and phones.
Management admits it is over-earning today. In its September 2021 investor day presentation, it estimated 2021 "baseline" revenue at around $900 million. However, due to the acceleration in semiconductors more broadly, as well as these new recent product introductions, Kulicke expects this baseline to grow at an 18.6% annualized rate, from around $900 million to $1.5 billion by 2024. That would be about flat from last year.
No doubt, flat results are nothing exciting, but if Kulicke and Soffa continues to buy back stock, it could retire a lot of its shares at these levels. Management forecast a new 2024 baseline EPS of $6.09 at that $1.5 billion revenue level, which is actually lower than its trailing-12-month EPS this year; however, that forecast assumed 63.5 million diluted shares outstanding.
Kulicke and Soffa's share count is already down to 59.1 million following the recent repurchases, so that $6.09 in EPS would already equate to $6.54 per share today. If management keeps generating cash for another year and buying back stock, that baseline EPS could be even higher.
It all adds up
Investors really don't like to own cyclical plays heading into a possible downturn; however, semiconductors are showing above-average strength right now, and these companies are generating lots of cash and buying back stock. Among many contenders, Kulicke and Soffa looks like the cheapest in the space, with the ability to repurchase more of its shares than others.
If the economy goes into a recession, there may be more downside ahead. Yet for long-term investors, this certainly looks like a good entry point for an industry leader that should grow over the long term. It's one of the best value stocks in the market.