Kulicke & Soff Industries, Inc. - Semiconductor Leader
Did the WVF really drop a Warren Buffett reference in the subtitle? You’re damn right we did and it’s for good reason. While the Oracle was buying Taiwan Semiconductor (TSM), 2k Hedge Fund was also diving headfirst into the industry, but coming out with a different value stock that needs mentioning.
Nothing against TSM, but here are some metrics for this week’s value stock:
No debt
Price to FCF < 10
Price to Cash < 5
~13% Short Float
What company am I talking about?
Kulicke & Soffa Industries, Inc. (KLIC)
Never heard of them? Good because I’m excited to be able to let you in on this little loved company that has been dumped with the rest of the semi-market.
Company Description
Simply put, the main revenue from KLIC comes in the form of designing, manufacturing and selling equipment that assembles semiconductors and then also helps to service, repair, and maintain said equipment. The company also provides die-attach equipment which connects components to electric circuit boards.
While this may seem like a simple business, it is not. Their equipment is used over a diverse range of wire bonding, advanced packaging, lithography, and electronic assembly. That being said, the majority of their revenue, almost 70%, comes from their advanced wire bonding.
The company splits their business into two main segments, Capital Equipment and Aftermarket Products & Services. The first represents equipment sold to the sub-markets it serves, General Semiconductor, Automotive & Industrial, LED, and Memory. The second represents their consumable spare parts and services revenue from its wire bonding business.
Below is a breakdown of revenue from the latest quarterly report:
Enough about the company description, let’s move on to the fun stuff!
MOAT
Oh me oh my, you all know I love a good moat story and in my opinion KLIC has a nice one. What you have to realize about the semiconductor packaging business is that it’s not one that someone can just start up a business and figure to compete. This business has a high Barrier to Entry, and that is precisely part of an extensive moat that KLIC enjoys. Along with this first set of guards, KLIC also provides advanced equipment that others do not, a Secrets moat. Add to this the costs that it would take many companies in both time and money to switch from their machines, and we find ourselves with a nice little trifecta of protection of Barrier to Entry, Secrets, and Switching.
This is what I like to see, so let’s move on to more positives about the company.
PROS
Spotless Balance Sheet. Like how Richard Gere had an affinity for working with Julia Roberts, I have an affinity for tremendous balance sheets. And there is no doubt that KLIC has one. With around a half billion in cash and equivalents, paired with no long term debt, the company has me right where they want me on initial looks. Add to this all the historical trajectory of the balance sheet that shows responsible management that is ready for any cyclical or economic downturn (see what happened in 1998-2002, 2008-2011, and most recently 2020).
Paying Back Investors. If you like good balance sheets, you are probably a fan of companies that hand back cash to their investors. If that’s the case, grab some champagne because you will want to celebrate KLIC. The company has raised its dividend for the past three years, with the recent raise being 11.8%. But the dividend is not the only thing that is driving the investor returns, as KLIC has also been buying back shares at an enormous rate. During the current buyback program, the company has repurchased almost 10% of outstanding shares and has enough money left to acquire another 10%.
Industry Cyclicality. If you know anything about semiconductors then you will know that the industry is cyclical and revenue can be somewhat volatile. While there has been a drop in demand, and there is a projection of lower semi revenue in 2023 (we will get to that later), the real story for me is what has occured over the past couple of years. With 2020 shutting down much of the industry worldwide, a chip shortage occurred and led to many companies over ordering in 2021-22 to make sure that they could have the inventory to produce goods. While this led to a spike in revenue for many companies, KLIC included, it has now led to a stockpile that is taking some time to liquidate. This though could be a positive, as many semi-related companies have taken a beating as the revenues have slowed or dropped. While the cycle may not be at true bottom yet, and according to some that is a couple quarters away, it seems like a much safer place to purchase a company like KLIC than even just a few quarters ago.
CONS
Falling Revenue. There’s nothing better than following up a shaky pro with a con that plays devil’s advocate. Revenues are falling right now for semiconductor companies as consumer demand is continuing to look shakier and shakier as a recession looms. With less discretionary money in hand, things such as upgraded phones, computers, cars, etc. are seeming to slow down for the time being. This, along with a margin that is compressing under KLIC’s 50% goal, may continue to cause a downward trend in the stock as investors shy away from a rising PE ratio. While many of these factors may be temporary, it places limits on near-term safety, especially if a recession hits harder than many expect.
Restrictions in China. This past August, the Biden administration signed the Chips and Science Act of 2022, aimed to strengthen and advance semiconductor production in the United States. This sent many semi names upward as investors saw a commitment to driving forward production, but what happened in October may mean more to a company like KLIC. In October, the same administration placed restrictions on Chinese access to advanced semiconductors and equipment that help produce them. While this currently does not include the equipment that KLIC produces, it does make you wonder how vulnerable the company could be with its 50% revenue coming from the company (some of that is from US companies that have factories there). Currently the company is showing a slowdown and projecting to at least meet or beat 2018 revenues in 2023, which would place them around the $900M plus, a solid decline from the $1.5B they produced this year. Here’s the quote from the most recent earnings report:
Based on this detailed feedback, we currently expect fiscal 2023 revenue to meet or exceed our previous cyclical peak revenue in fiscal 2018. This outlook suggests a more typical seasonal pattern through fiscal 2023, with ongoing digestion in the first fiscal half followed by gradual demand improvements in the second fiscal half. Expected second-half improvements are supported by well-known seasonal dynamics in addition to a heavier weighting of advanced display and advanced packaging revenue.
-Fusen Chen CEO
R&D Expenses. The biggest risk for a company like KLIC is continuing to meet the demands of the space as new technology develops. Management has shown a consistent history of meeting or leading the industry and customer needs, but there is always a chance of a misstep that causes them to start market share degradation. With fairly regular spending on R&D between $120-$130M per year, a misguided approach could lead to disaster.
CONCLUSION
There’s no denying that Kulick and Soffa Industries, Inc. is a boring company in an exciting industry, and that is exactly why I like them. They have shown consistent responsibility with their balance sheet and product development, as well as with the acquisitions they have historically made. While the risks are weighing heavy in the near term due to economic factors out of their control, they are positioned to weather the storm with their large cash position and high margins.
But should I add the company to my portfolio?
If I am following the 2018 similarity guidance that Mr. Chen is giving then there is an argument to say that waiting is the prudent thing to do. In 2018 the company produced just over $100M in free cash flow, something that will pretty much be erased after dividend and buybacks. Judging by historical ratios, the company may continue to drop as the market adjusts to the dropping revenues and earnings. While the market has already dropped KLIC ~35% from its 2021 highs it just doesn’t seem quite safe yet to jump in due to the current risks.
I’m really on the fence on this one, because if 2021/2 revenues are realized again in 2024, something I think is highly probable, then this company is nicely priced and I can say with full conviction that in a few years we will be looking back at this as a bargain. The problem in my eyes is that the margin of safety over the next 6-12 months isn’t leaving me running to tie up my money to sit and wait, even with the safety net of their cash per share of ~$10.
Verdict: KLIC is a definite watchlist add, and a portfolio add at some point in the Q2/3 of 2023 before we begin to hit an increased demand for their products.
As always, thanks for reading, and happy investing!
The Profit Investigator