The semiconductor sector has been a mixed bag in 2023. To be blunt, artificial intelligence (AI) masked substantial weakness across the industry as consumers pull back on buying big-ticket electronics like computers and mobile devices.
Chip companies focused on AI have done extremely well; Nvidia, for example, experienced a surge in its data center revenue thanks to that technology, and its stock is sitting on a mammoth gain of 246% this year so far. But even that company has seen weakness in its consumer-focused gaming segment.
Cohu (COHU 0.78%) is a unique semiconductor service company, and it's on track to experience a 21% drop in its total revenue this year. As a result, its stock is trading 30% below its all-time high. Even though the company isn't focused directly on AI, I'm going to explain why its stock is a great value right now.
Cohu is a key part of the chip industry
Cohu doesn't make any chips. Instead, it offers a slate of services to some of the world's largest producers, in addition to a portfolio of testing and handling equipment, which is paramount to the quality control process. Right now, the company has over 24,600 systems installed with 108 different customers.
Semiconductors require different tests during manufacturing. Thermal testing is designed to put the chip through a harsh range of cold and hot temperatures to identify any potential failures in early production. Defect detection is another important process designed to visually spot cracks or imperfections that could become a threat to the chip's functionality.
Cohu's equipment covers all of those needs. In fact, the company's inspection process uses advanced technologies like true infrared to penetrate the semiconductor wafer, identifying cracks as small as five micrometers. They would be impossible to see with the naked eye -- a human hair is about 70 micrometers thick. Then, Cohu uses artificial intelligence algorithms to distinguish between actual cracks and harmless cosmetic defects.
Cohu serves chipmakers in a very wide range of industries, including consumer electronics, mobility, healthcare, and automotive manufacturing. Unfortunately, many of those segments suffered from a drop in consumer spending this year.
Investors are bracing for a full-year revenue drop
Cohu generated $499 million in revenue through the first nine months of 2023, which was a 19% decline compared to the same period last year. Based on the company's revenue forecast of $136 million for the fourth quarter, its 2023 full-year revenue should land around $635 million.
That would represent a drop of 21% compared to 2022, when Cohu delivered $812 million in revenue, marking its second consecutive annual decline.
In its third-quarter conference call with investors, the company said it's experiencing weakness in the automotive segment, which makes sense given the challenging economic environment -- consumers are simply being more cautious with large purchases. Plus, considering two of Cohu's automotive customers accounted for over 10% of the company's total Q3 sales, cracks in that segment can really hurt its growth prospects.
However, profitability was one bright spot. Cohu focused on building its recurring revenue streams (which now make up over half of the company's total revenue) because they carry a high gross profit margin of 55%, compared to systems, which carry a gross margin of 39%. Recurring revenue comes from software products and service-based activities, like helping customers operate and maintain their systems.
Combined with careful expense management, Cohu was able to deliver $1.39 in non-GAAP (adjusted) earnings per share in the first nine months of 2023. While that was a drop of 37% from the year-ago period, it's clear the company's bottom line is far more resilient than it was in 2019, when it was in the red on a similar amount of revenue.
Image source: Getty Images.
Why Cohu stock is a buy now
Here's the great news: Wall Street expects Cohu to return to growth in 2024 at both the top and bottom lines. That growth is forecast to be relatively modest, with revenue potentially increasing by 2.7%, and earnings per share by 3%. But it would mark an important, positive reversal after a tough couple of years.
Plus, Cohu just acquired a small company called Equiptest Engineering, which will expand its test interface product portfolio. It will benefit Cohu's financial results almost immediately, and contribute $20 million in predictable annual recurring revenue going forward.
Cohu is still expanding internally even in the face of its slowdown. The company is about to complete a 92,000-square-foot facility in the Philippines, which is expected to be operational in the first half of 2024.
If those factors aren't enticing enough, consider Cohu's current valuation. Based on its expected $1.61 in 2023 full-year non-GAAP earnings per share, and the company's current stock price, it trades at a price to earnings (P/E) ratio of 20. That's a 32% discount to the Nasdaq-100 technology index, which trades at a P/E ratio of 30.3.
Of course, most of the leading companies within the Nasdaq-100 index are delivering growth at the moment, and Cohu is not, hence the discount. But that could change as soon as next year, so now might be a good time to buy Cohu stock ahead of a potential upswing in its business. Investors who can hold the stock for a few years -- or at least until the present economic turbulence subsides -- might reap the most rewards.
