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Thermal Chip Stock Should Heat Up

09/25/2007 12:00 am EST


John Buckingham

Editor, The Prudent Speculator

John Buckingham of The Prudent Speculator and TechValue Report, says shares of chip equipment maker Cohu have been depressed, but he thinks they could have a turnaround.   

Cohu (NASDAQ: COHU) is not as inexpensive as it was when we last wrote about the chip equipment manufacturer back in April 2006. Profitability has declined greatly as gross margins dropped and operating margins sunk even further. And the stock may have further to fall before investors find new interest. But a strong balance sheet and a history of great comebacks keep our interest.

Cohu’s focuses on thermal “pick and place” test equipment, [which is] used to move chips around in a manufacturing environment and simulate hot and cold operating environments to make sure they’re up to snuff.

[Last] summer, Cohu noted that its thermal systems business was off considerably, and high-speed test solutions generated the great majority of sales. Competition is greater on that side of the business, and margins are weaker, too, impacting overall profitability.

Back in 2005, thermal handlers made up about two-thirds of revenue, resulting in an overall gross margin of 40%. A year later, however, high-speed handlers made up 40% and thermal comprised about 35% of revenue, resulting in a gross margin of 33%.

In the latest quarter, thermal handler sales made up just 5% of revenue, a decline offset by an increase in thermal subsystem revenue. These machines are used in advanced burn-in systems, which can both heat and cool a device.

The addition of thermal subsystem products was part of a plan to diversify the company’s product line with higher-margin devices to offset what’s now been well more than a year’s worth of weak demand for thermal test handlers. Newer thermal subsystem models are expected to generate substantial revenue in the current quarter. Their profitability should improve going forward.

A second target of growth has been the addition of customers in other chip segments. They won’t mention them by name, but for more than a year now, Cohu has been working with graphics chipmakers ATI and Nvidia. And Texas Instruments seems to be a Cohu fan, as is at least one more major wireless phone chipmaker.

Both these groups, in addition to other chip manufacturers focused on consumer electronics, should provide a boost to Cohu’s top line as we head into the latter part of 2007. And management sees itself “in the very early innings of the game,” suggesting additional gains will come.

Less than two years into our ownership of the stock, we remain enthusiastic about Cohu’s long-term growth potential, including the ability to favorably consolidate the sector afforded by a cash-strong ($6.95 per share) balance sheet. Valuation metrics should improve as margins recover and the top line benefits from the addition of new revenue streams. We have the sense that such improvements will draw investors back into the relatively attractive shares. (Cohu’s stock closed below $19.50 Monday—Editor.)

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