Computer chips play a central role in a growing number of different goods and services, from consumer smartphone devices to electric vehicles to the cloud computing platforms relied upon by businesses. These chips are commercially known as semiconductors, and the industry is shaping up to be a $1.5 trillion annual opportunity by 2030, which means investors could benefit greatly from adding quality chip stocks to their portfolios.
Cohu (COHU -1.57%) is a service-focused company that provides critical equipment to the world's leading semiconductor producers. Despite Cohu's growth slowing down in 2022, it's on track to hit some ambitious financial targets over the next five years, and the stock is trading at an extremely attractive level right now. Here's why investors should consider shares of this tech specialist to buy and hold long-term.
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Cohu has a broad reach
Cohu makes testing and handling equipment that allows chip producers to keep manufacturing moving quickly without sacrificing state-of-the-art defect detection processes. It's critical that the end user receives hardware that functions as intended given the important role chips play in the function of digital products.
Cohu applies advanced technologies like artificial intelligence to identify cracks as small as 5 micrometers (for context, a human hair is around 70 micrometers). But not only can it identify such issues, but it can also distinguish between true structural faults and harmless cosmetic defects to maximize production yield for Cohu customers.
The company's strength is in its diverse expertise. Its equipment is used to test, handle, and inspect chips used in a variety of applications including computing, consumer electronics, automotive applications, and even mobility, which encompasses 5G network technologies. The automotive segment was Cohu's largest source of revenue in 2021, and after briefly handing that title to the mobility segment in the first quarter of 2022, it was once again Cohu's largest in Q2, which was reported on July 28.
Automotive made up 17% of Cohu's total revenue base, and it's not surprising given the persistent new car shortages over the last couple of years. Car manufacturers are still playing catch-up from the pandemic lockdowns, and chipmakers have expanded their capacity to meet soaring demand from that industry as vehicles become more intelligent.
Cohu's long-term financial picture is very bright
Cohu generated $217.2 million in revenue during Q2, which was a 9.8% increase compared to Q1, but it equaled an 11.2% decline versus the prior-year period. The semiconductor sector broadly isn't expected to repeat the financial numbers it delivered during 2021, because that year was boosted by stimulus dollars, as well as supply shortages in 2020, which led to sales carrying into the next year instead.
Earlier this year, Cohu upgraded its midterm financial forecast, which now suggests it will generate $1 billion in annual revenue, on average, over the next three to five years, in addition to $4 in earnings per share. It has also targeted a 49% gross profit margin by then, and the company is inching closer to that goal each quarter. Its gross margin hit 46.5% in Q2, a sizable jump from 42.7% in the year-ago period.
Cohu thinks it can build upon its revenue compound annual growth rate of 26% over the last five years, and it's certainly possible given how critical semiconductors are becoming to more goods and services.
Cohu stock is a great value
Over the last four quarters, Cohu has generated non-GAAP net income of $142.5 million, which translates into $2.89 in earnings per share. That gives its stock a price-to-earnings multiple of just 9.9. That's a 50% discount to the broader chip industry as represented by the iShares Semiconductor ETF, which trades at a multiple of 20.
It implies Cohu stock would have to double just to trade in line with its peers in the semiconductor sector.
The company is also returning money to shareholders in the form of a share buyback, which is designed to shrink the total number of Cohu shares in circulation, in turn making each remaining share more valuable. It repurchased $14 million worth of its own stock in Q2 as part of a larger $70 million program.
Cohu isn't a short-term story, but its stock trades at a very attractive price right now. Investors who buy in should do so with the intention of holding until at least 2025, which is the lower end of the company's midterm financial model. If Cohu stock moves in line with the broader chip industry over that period, patient investors could reap significant rewards.
