With today’s market close, the S&P 500 finished the second of the week on a high note. Positive momentum on the trade front between the U.S. and China seems to be give the market some optimism, and a reason to start looking for encouraging signs that the economy not only still is healthy, but that it could remain that way for even a little bit longer than it already has. Earlier this week, for example, the President of the Chicago Fed said in an interview that while the economy looked good, the Fed could afford to patient about raising rates in the year ahead.
That news seemed to help quell some of the lingering fears around interest rates and whether the Fed’s policy of gradual rate increases, along with its ongoing efforts to reduce its balance would start to restrict growth. All together, that seems to given investors reason to push the market higher in the very early stages of 2019; the S&P 500 is up a little over 6.5% since January 1.
Not too surprisingly, one of the sectors that has been keeping pace with the broad’s market increase is Semiconductors. I don’t think it’s unreasonable to suggest that positive movement on the trade front should be a good thing for tech stocks in general, and semiconductors in particular, as much as anything because of the simple fact that the Trump administration made technology and intellectual property protections one of the centerpiece arguments for its case on increasing tariffs against America’s biggest trading partner. As measured by the iShares Semiconductor ETF (SOXX), the sector is up almost exactly the same amount as the broad market. Does that mean that the time might be right, right now, to start jumping back into semiconductor stocks? I think it is a possibility. Any kind of trade deal or compromise at this stage, no matter whether great or small, is likely to be met with enthusiasm by the market, and that means that the sectors hardest hit by the impact of tariffs, like semiconductors could be in a perfect position right now.
The counter to the market’s bullish momentum, of course is that two weeks does not a trend make; and the reality is that the broader trend, not only for the broad market, and for semiconductors, remains sharply lower. Basic trend analysis holds that the best way to make sure you are usually on the right side of the market, you need to focus on the longer trend than the trade you’re thinking about making. That’s why I prefer to work with long-term trends whenever possible. As a value investor, of course, I’m more than willing to buy a stock in the midst of a downward trend if the bargain opportunity is good enough to justify the risk that the stock could keep dropping. The momentum the semiconductor sector is seeing right now could offer a good opportunity to take not just take advantage of some great valuations in a couple of what I think are the strongest companies in the sector, but also to get in at the earliest stages of a potential bullish trend reversal. Let’s take a closer look at each stock in more detail.
KLA-Tencor Corporation (KLAC)
At a price that is just a little below $100, it might be hard to see KLAC as a bargain-priced stock; after all, buying just 100 shares would take up more than $9,500 of your trading capital, which is a significant sum of money even for experienced, long-term investors. Don’t be fooled, however; the over value value proposition for the stock is very attractive, even at the stock’s current price. One of the things that I think makes KLAC an interesting semiconductor stock is that they supply products and services for the sector; they’re like the businessmen that sold shovels to prospectors during the California Gold Rush.
Fundamental and Value Profile
KLA-Tencor Corporation (KLA-Tencor) is a supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. The Company’s products are also used in a number of other high technology industries, including the light emitting diode (LED) and data storage industries, as well as general materials research. Its products and services are used by bare wafer, integrated circuit (IC), lithography reticle (reticle or mask) and disk manufacturers around the world. The Company’s inspection and metrology products and related offerings are categorized in various groups, including Chip Manufacturing, Wafer Manufacturing, Reticle Manufacturing, LED, Power Device and Compound Semiconductor Manufacturing, Data Storage Media/Head Manufacturing, Microelectromechanical Systems (MEMS) Manufacturing, and General Purpose/Lab Applications. It also provides refurbished KLA-Tencor tools as service and support for its products. KLAC’s current market cap is $14.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings grew more than 36% while revenues increased by almost 13%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long-term; but it is also a positive mark for management’s ability to maximize its business operations. In the last quarter, earnings grew by almost 11%, while sales increased about 2%. KLAC operates with a very strong margin profile, with Net Income running at 22% of Revenues over the last twelve months, and increasing impressively over the last quarter to 36%.
Free Cash Flow: KLAC’s free cash flow is healthy, at a little more than $1.1 billion and translates to a useful Free Cash Flow Yield of 8.13%.
Debt to Equity: KLAC has a debt/equity ratio of 1.43. At first blush, that seems high; but a look at the company’s balance sheet provides a better perspective and shows that their debt is very manageable. The company has a little over $2.2 in long-term debt, but almost $2.8 billion in cash and liquid assets as of the last quarter. Along with their very impressive operating margins, this means that the company has both the ability to service their debt without difficulty, as well as excellent liquidity and financial flexibility.
Dividend: KLAC pays an annual dividend of $3 per share, which translates to a yield of about 3.23% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KLAC is $10.24 and translates to a Price/Book ratio of 9.34 at the stock’s current price. That seems high for an investor like me, who generally prefers to see ratios as close to 1 as possible; but their historical average Price/Book ratio is 15.14, which suggests the stock is trading right now at a discount of about 67%. That may seem very optimistic, especially since it puts a long-term target price above $150 per share. The stock’s all-time high was reached in March of last year around $124 per share, so I do think this is an over-optimistic forecast; however the stock’s Price/Cash Flow provides a more conservative, but still very attractive target since the stock trading about 26.5% below that historical average and puts the stock’s long-term target at a more reasonable $116. No matter which target you prefer to work with, KLAC looks like a stock that offers an excellent bargain opportunity.
Micron Technology (MU)
I think Micron Technology (MU) is a good example of an industry leader with a major competitive advantage. Despite intense competition, MU remains the unquestioned king of the hill in the memory space. This week that fact only became even more prevalent when the company announced a $1.5 billion dollar deal to purchase Intel Corp’s (INTC) share of the IM Flash joint venture that was launched more than a decade ago for $1.5 billion. The market seems to view that move favorably, as it gives the company complete autonomy in the operations of a segment that has helped drive the company’s growth in solid state memory storage.
While there are a number of stocks in the industry that think are also very interesting, MU’’s industry leadership, along with its incredibly solid fundamental profile are the primary reasons that I think this company is better positioned than the competition to weather whatever storms the market blows its way over the next few years. When you add to that the fact that the stock is down about 47% since the summer of 2018, you get a value proposition that I think is very hard to ignore.
Fundamental and Value Profile
Micron Technology, Inc. (MU) is engaged in semiconductor systems. The Company’s portfolio of memory technologies, including dynamic random-access memory (DRAM), negative-AND (NAND) Flash and NOR Flash are the basis for solid-state drives, modules, multi-chip packages and other system solutions. Its business segments include Compute and Networking Business Unit (CNBU), which includes memory products sold into compute, networking, graphics and cloud server markets; Mobile Business Unit (MBU), which includes memory products sold into smartphone, tablet and other mobile-device markets; Storage Business Unit (SBU), which includes memory products sold into enterprise, client, cloud and removable storage markets, and SBU also includes products sold to Intel through its Intel/Micron Flash Technology (IMFT) joint venture, and Embedded Business Unit (EBU), which includes memory products sold into automotive, industrial, connected home and consumer electronics markets. MU’s current market cap is $38.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings grew by 21.5%, while revenues increased by a little over 16%. Those levels are lower than in recent quarters, and the company has attributed some of that decline to trade concerns and tariffs, which means that could continue to be a headwind this year. In the last quarter, in fact, earnings actually decline a little over -16%, while sales dropped by -6%. Even with the price pressure that are attributed to trade, ongoing competitive pressures, and slowing demand versus supply, the company operates with one of the biggest margin profiles that I’ve seen in the marketplace, with Net Income running at a whopping 47% of Revenues for the last twelve months, and 42% in the last quarter.
Free Cash Flow: MU’s free cash flow is very healthy, at more than $8.9 billion. That translates to an outsized Free Cash Flow Yield of 23%.
Debt to Equity: MU has a debt/equity ratio of .11. This number reflects the company’s manageable debt levels, and has dropped over the last two quarters from .2. The company’s balance sheet indicates cash and liquid assets are a little over $5 billion versus debt of about $3.7 billion.
Dividend: MU does not pay an annual dividend, which is the norm for most tech stocks.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MU is $30.99 per share, and has increased from $25.45 per share two quarters ago. That number also translates to a Price/Book ratio of 1.15 at the stock’s current price. Their historical average Price/Book ratio is 1.98. That suggests the stock is trading right now at a discount of about 80%, and that puts the stock’s long-term target above $61 per share. That might sound pretty ambitious; and while the stock’s Price/Cash Flow ratio offers a more conservative 57% upside, that puts the stock’s long-term target price range between $53 and $61 – which is very nice no matter how you consider it.