Advanced computer chips -- commercially known as semiconductors -- are constantly growing in demand as our lives trend further into the digital realm. The electronic devices we use each day, and the cloud computing services that host our online experiences require more powerful hardware than ever.
The semiconductor industry could be worth over $1.5 trillion annually by 2030, according to an estimate by Fortune Business Insights. But while most investors are focused on high-flying chip makers like Nvidia and Advanced Micro Devices, they might be missing an enormous amount of value in the lesser-followed areas of the sector.
Cohu (COHU 0.65%) is a semiconductor-service company, and it just released its earnings report for the third quarter (ended Sept. 24). Here's why it's a hand-over-fist buy.
Image source: Getty Images.
Cohu is a critical part of semiconductor manufacturing
Cohu doesn't produce any chips. Instead, it makes a range of testing and handling equipment designed to help the largest semiconductor manufacturers operate more efficiently, which can lead to higher output and less waste.
Cohu's advanced technology can inspect semiconductors of all sizes to identify structural defects as small as 5 micrometers, which wouldn't be visible to the naked eye. It uses true infrared combined with artificial intelligence to analyze cracks and determine whether they're of concern or simply cosmetic, which ensures the end-user receives a functional product.
The company operates in six main segments, but its automotive and its mobility units are among its largest. Within them, it serves customers producing chips for electric vehicle applications and 5G-related technologies, both of which are high-growth areas that Cohu could benefit from over the long term.
Cohu has a 23,700-equipment-installed base across 280 customers in 31 countries, all of which require upkeep and a range of services from spare parts to remote support. This has enabled the company to build a steady stream of recurring revenue to supplement sales of its systems.
Cohu generated less revenue, but more profit
Cohu had an incredibly strong year in 2021 as chip manufacturers expanded their production capacity to fill supply shortages left in the wake of COVID-19 lockdowns. But that tailwind has abated, and the industry as a whole has slowed, dealing Cohu a modest decline in revenue more recently.
The company generated $206 million in sales in the third quarter, down 8% compared to the same period last year. But it has operated a much leaner business, resulting in a gross profit margin expansion of more than 5% to 47.5%. It means despite the company bringing in less revenue, its non-GAAP (adjusted) earnings per share actually grew by 5% to $0.74.
It comes as Cohu's recurring revenue streams make up an increasing amount of the company's total revenue base. Recurring sources of income tend to come with fewer costs because they're more predictable, and in this case, Cohu had a 54% gross profit margin in that area of its business in Q3, which is substantially higher than its overall margin.
But overall, Cohu is working toward $1 billion in average annual revenue and $4.00 in average annual earnings per share over the next three to five years, so it implies a return to faster growth rates might be around the corner.
Why Cohu stock is a buy now
Cohu stock has soared by 30% over the past month alone, yet based on its adjusted trailing-12-month earnings per share of $2.93, it trades at a price-to-earnings ratio of just 11.5.
That's a 28% discount to Cohu's peers in the chip industry represented by the iShares Semiconductor ETF (SOXX -1.14%), which trades at a ratio of 16.1. Therefore, despite Cohu's growing profitability and its robust mid-term financial targets, investors can pick up its stock at a relative bargain to the rest of the sector.
Goods and services are only going to trend further toward digitization over time, especially with the onset of new technologies like electric vehicles. Chips will need to be more powerful and more advanced, which will likely make them more valuable. As the stakes continue to rise, Cohu's equipment can ensure producers are yielding the best results from their manufacturing processes.
That's an opportunity that investors might want to take advantage of.
