Sector Watch: Semiconductor stocks
Still have a phone that only makes phone calls? That’s so 20th century; these days, the relic of a standard cell phone has been surpassed by devices that can do everything from record video to surf the Web to get directions to Manhattan. There are still some things these all-in-one devices can’t do, such as clean your house or walk your dog, but you never know: Silicon Motion Technology Corp. (Nasdaq:SIMO) and EXFO Electro-Optical Engineering (Nasdaq:EXFO) may be working on that, too.
Because of technology advances, different types of electronic devices now offer similar functionalities. Mobile phones for example, have become multimedia devices with integrated camera, video, music, e-mail, Internet and television. Most new personal computers have wireless connectivity, Internet and video phone and advanced video and audio capabilities.
Flash drives (self-contained devices using flash memory as their data storage medium) are one of the advances that enable these devices to be multi-functional and are rapidly replacing floppy drives as the storage medium in electronic devices because of their smaller size, superior data storage capacity, ease of use, rewrite capability, speed and security. Gartner Dataquest estimates that the worldwide market for USB flash drives grew 66% annually to $1.7 billion in 2007 from $135.6 million in 2002.
Silicon Motion designs, manufactures and markets universally compatible, low-power semiconductors for the consumer electronics market. Its core business involves mobile storage devices, commonly known as controllers, used in flash memory cards, USB flash drives and card readers. The company’s products power mobile phones, digital cameras, personal digital assistants, car navigation systems, multimedia players and notebook and personal computers.
Silicon Motion’s customers include Samsung, Sony (NYSE:SNE), Lexer Media, STMicroelectronics (NYSE:STM) and Transcend. The company also sells mobile communication solutions, including mobile television tuners, radio frequency integrated circuits, mobile phone circuits and electronic toll collection circuits for transmitting data between cars and highway toll collection systems. Products are sold through a direct sales force and distributors in North America, China, Europe, Japan, Korea, Singapore and Taiwan. Approximately 70% of the company’s sales are made in Asia.
Demand for flash drives is driving Silicon Motion’s sales, which have grown 59% annually since 2003. Last year, the company’s sales rose 69% to $180 million, from $107 million in 2006. Growth continued in the first quarter ended March 31, 2008, with sales up 35% year over year to $52.2 million from $38.6 million. Unit shipments hit record levels of approximately 113 million in the 2008 first quarter, up 73% year over year and 17% from the 2007 fourth quarter. First-quarter 2008 non-GAAP net earnings (excluding non-cash charges) improved 27% year over year to $15.4 million from $12 million, and per-share earnings rose 19% year over year to $0.44 from $0.37. Silicon Motion anticipates full-year 2008 revenues in a $225 million to $235 million range, up 25% from last year, and per-share earnings ranging between $1.95 and $2.05, at least 19% higher than last year.
Given the company’s robust growth, Silicon Motion appears reasonably priced at a 15 times P/E multiple and a seven times forward P/E multiple. My $25 price target for Silicon Motion is 36% above Tuesday’s closing price of $18.38. Shares have ranged between $12.40 and $29 over the last 52 weeks.
EXFO is the world’s second-largest provider of portable telecom system test and measurement tools. The company sells its devices to network service providers, cable TV operators, telecom system vendors and component manufacturers. EXFO testing equipment is used to ensure networks are delivering secure, reliable triple play services (i.e., Internet voice, video and data) and converged IP networking.
Like Silicon Motion, EXFO generates significant sales outside the United States. Europe and Asia Pacific represented approximately 50% of the company’s second-quarter 2008 sales. EXFO has a strong new product pipeline with recently introduced products contributing 44% of second quarter’s sales and likely to account for at least 40% of full-year 2008 sales.
EXFO benefits from strong growth in the worldwide wire line telecom market. Global Internet bandwidth demand grew 45% annually between 2003 and 2006 and continues to expand at double-digit rates due to the rollout of IP television, high definition IP television, online video streaming and other technologies requiring significant bandwidth. EXFO products address a $2 billion market believed to be growing 10% to 15% annually.
In the last 10 years, EXFO’s sales have expanded at a 20.1% compound annual rate. Last year, the company’s sales rose 19% year over year to $152.9 million from $128.3 million. Net earnings grew four-fold to $42.3 million in 2007 from $8.1 million in 2006. Sales also grew 19% year over year in the first six months of FY 2008 to $84.3 million from $70.7 million, but net earnings declined due to increases in the value of the Canadian dollar versus the U.S. dollar. EXFO records most of its sales in U.S. dollar but recognizes its expenses in Canadian dollars. As a result, the company’s net earnings fell to $3.9 million, or $0.06 per share, in the first six months of FY 2008 from $6.2 million, or $0.09 per share, in the first six months of 2007.
EXFO is expanding its product offerings and cross-selling opportunities through acquisitions. In April, the company acquired Canadian-based Navtel Communications, a provider of IP multimedia subsystem and VoIP test equipment. This acquisition will be accretive to 2009 earnings. EXFO also acquired U.S.-based Brix Networks, a global provider of converged service assurance solutions. The Brix Networks acquisition will be neutral to 2008 and 2009 earnings but should be accretive to 2010 earnings.
Industry analysts think EXFO can produce 70% growth next year and 29% average annual growth over the next five years. These shares are modestly priced at an eight times P/E multiple. My $7 price target for EXFO is 40% higher than the company’s closing price of $4.99 on Tuesday. Over the last 52 weeks, shares have ranged between $3.75 and $7.83.
About the Author
Contributing author Lisa Springer is an equity research analyst with nearly 20 years of investment research experience.
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