The semiconductor industry is going through a challenging period thanks to a slowdown in economic activity. It has led to a decline in revenue for some of the world's top chip producers, including Advanced Micro Devices.
The knock-on effects have also impacted semiconductor-service company Cohu (COHU 0.78%), which makes critical testing and handling equipment. It has seen a 16% drop in sales in the first six months of 2023 compared to the year-ago period.
But the environment could be set to shift as the new year approaches, and analysts on Wall Street are predicting Cohu's revenue will return to growth in 2024. The company's stock currently trades about 26% below its all-time high and it's incredibly cheap compared to the broader market, so here's why this might be a great time for investors to buy ahead of the new year.
Cohu plays a vital role in chip production
Advanced semiconductors are finding their way into more consumer products -- even refrigerators have internet connections nowadays. As a result, chips need to be smaller and more powerful than ever to suit a growing number of use cases. That complicates the manufacturing process, and Cohu's testing and handling equipment plays a crucial role in quality control.
The company's Neon system, for example, can inspect chips as small as 0.2 millimeters by 0.4 millimeters at speed, so as not to slow down the production process. Cohu's systems use advanced technologies like true infrared to penetrate the wafer, which helps identify structural damage below surface level. Plus, they rely on artificial intelligence (AI) to determine whether scratches are merely cosmetic or compromise the integrity of the chip -- even if those defects are as small as five micrometers.
The company's equipment is used by chipmakers operating in a broad variety of industries, from automotive to consumer electronics to mobility, with dozens of products and systems in its portfolio. The automotive segment is currently its largest by revenue, as vehicles come fitted with more electronic sensors and digital features.
Cohu's revenue shrank in the first half of 2023
Cohu's revenue came in at $812 million during 2022, which was a 8% decline compared to its record-setting 2021 result. That weakness carried into 2023. The company recently reported its financial results for the first half (ended June 30) and revealed a 16% drop in revenue compared to the first half of 2022.
Semiconductor producers like AMD also reported weak results lately, because consumers aren't spending as much money on big-ticket electronics in light of this economic environment. If chip producers aren't experiencing growth, they are unlikely to expand their manufacturing capacity as quickly, which means less demand for Cohu's equipment.
Cohu's earnings were also down in the first half of 2023, but thanks to careful expense management, it still generated $49.8 million in non-GAAP net income, or $1.04 per share.
According to Wall Street, the rest of 2023 won't be much better. Analysts are expecting the company to bring in $654 million in total annual revenue, which would mark a 19% drop compared to 2022.
But here's why investors should buy Cohu stock for the long term
Cohu has laid out financial projections spanning the next three to five years that suggest the company will average $1 billion in annual revenue and $4 in non-GAAP earnings per share (EPS) over that period. Considering the Street's $654 million revenue estimate for 2023, that suggests 53% growth might be ahead.
Let's talk about valuation. Analysts believe Cohu will deliver $1.73 in EPS this year, which places the stock at a price-to-earnings (P/E) ratio of 21.5 based on its recent price of $37.27. That means Cohu stock is 29% cheaper than the broader technology sector represented by the Nasdaq-100 index, which trades at a P/E ratio of 30.2 as of this writing.
But it gets better. If Cohu does eventually generate $4 in EPS, its current stock price will look like an absolute steal a few years from now, because it implies a forward P/E ratio of just 9.3. In that scenario, Cohu stock would have to triple from its current price just to trade in line with the Nasdaq-100.
Wall Street expects the company to take a big step toward that goal next year. It's expecting Cohu's EPS to soar by 42% to $2.47 on the back of $736 million in revenue, which would mark a return to growth for both metrics.
Therefore, not only is Cohu stock attractively priced based on this year's beaten-down outlook, but it looks even cheaper when factoring in its potential results in 2024 and beyond.
