A Low Risk Way To Play The Recovery In Chip Stocks

| March 11, 2010 | 0 Comments

At the beginning of 2009, it looked like the semiconductor industry was going to have the worst year in its history.  Thanks to the financial crisis, demand for silicon chips had fallen off a cliff.  And, no one expected the industry to recover any time soon.

I guess it’s true that “it’s always darkest before the dawn.”

Instead of spiraling further down, the industry hit bottom in March.  It then proceeded to recover gradually throughout 2009.  When all was said and done, chip industry revenues declined just 9%.

A much better result than anyone expected.

The recovery is continuing to gather momentum in 2010.  In January, chip sales soared 47% over last year’s anemic levels.  And, they increased slightly over December 2009’s strong numbers.

The Semiconductor Industry Association is now calling for a return to “normal” growth in 2010.

While this is definitely great news for chip makers, it also bodes very well for semiconductor equipment manufacturers.

These companies supply the machines and tools chip makers use to manufacture semiconductors.

The chip equipment makers suffered two straight years of huge declines.  Industry sales plunged 46% in 2009 after a hefty 31% drop in 2008.  In December 2009, industry sales hit rock bottom… the lowest levels seen since 1994.

Chip makers essentially stopped investing in new manufacturing equipment in late 2008.  Now, as business starts to recover, we’re seeing an uptick in equipment order bookings.

In January 2010, North American chip equipment makers posted a huge 24% increase in bookings over December’s figures.  And, bookings were three times higher than in the year ago period.

Bookings are now at the highest levels seen since April 2008.

Clearly, all signs point to a strong recovery in the chip equipment industry this year.

In fact, the industry’s trade association recently forecasted strong growth for the next two years.  They’re expecting chip equipment sales to grow a whopping 53% in 2010 and 28% in 2011.

This is definitely one trend you don’t want to miss.

Shares of chip equipment makers tend to post huge gains during the early stages of an industry growth cycle.  And, I’ve found one poised for big gains in the months ahead.

The company is MKS Instruments (NASDAQ: MKSI).

MKSI provides instruments, subsystems, and process control solutions to chip equipment manufacturers.  Customers employ MKSI’s technology in equipment for making semiconductors, flat panel displays, solar cells, and data storage media.

I know this sounds complicated.

Here’s what you really need to know.

The company’s products help improve the performance and productivity of the end user’s manufacturing process.  (An extremely critical function for any manufacturer.)

MKSI’s customer list reads like a Who’s Who of the chip equipment industry.  Their top customers are industry leaders Applied Materials, Lam Research, and Novellus Systems.

With customers like these, it’s no wonder MKSI’s products typically rank #1 or #2 in market share.

Now, if you look at the company’s full year results for 2009, you’d think the company is doing poorly.  Revenue declined sharply.  And, the company posted a big loss.

But, you’d be missing the developing trend.

The poor full year results were due to sharp declines in revenue and earnings in the first two quarters of 2009.  The company actually began recovering in the last two quarters of the year.

Just look at the fourth quarter’s results compared to the third quarter’s.

Revenue surged 41% to $149 million.  Net income increased to nearly $15 million from a loss of ($4 million).  And, the company posted a profit of $0.30 per share compared to a loss of ($0.08) per share.

Management expects the recovery to accelerate this year.

The company’s CEO recently said, “After enjoying a very positive uptick in sales in the past two quarters, we expect to see continued growth in the semiconductor market in 2010.”  (That’s straight from the horse’s mouth.)

Analysts are jumping on the bandwagon too.

They recently doubled their estimates for the March and June quarters.  They raised the consensus 2010 estimate from $1.02 to $1.80.  And, they ratcheted up the consensus 2011 estimate from $1.48 to $2.18.  (These are huge upward revisions to earnings.)

The stock is now poised for big gains in the months ahead.

At a recent price of $19 per share, MKSI’s trading about 10x the 2010 estimate.  This is an extremely low valuation for a company expected to grow earnings 20% annually over the next five years.

If the global economy and the semiconductor industry continue recovering, I wouldn’t be surprised if the company’s P/E ratio doubles to 20x.

At a P/E of 20x, the shares would be worth $36 a share.

That’s potential upside of 89%!

Take a closer look at MKSI for your own portfolio.  This high quality small cap stock offers a very attractive risk/reward profile.  And, it could really supercharge your returns this year.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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