A Closer Look at LTX-Credence
We're rapidly approaching the last chance to take advantage of the biggest single news item for small cap stocks this year. For those who have been reading Small Cap Investor Daily this week, you know that the preliminary listing of the new Russell indexes come out tomorrow afternoon. You still have until the 25th for the final listing, but the stock run-up typically begins in earnest once the preliminaries are announced.
That means today and tomorrow morning are the last opportunities to buy the stocks that I believe are likely to be listed on the new Russell, and to take advantage of the listing bump. I’ve led you to the water, and while I can’t make you drink, I want to remind you that last year the one day average bump for stocks joining the Russell 2000 was upwards of 8%.
In yesterday's issue I introduced you to four stocks that not only met all the criteria to make it into the new Russell, but also looked pretty good on their own. I like all of those stocks, but one really caught my eye, and the attention of more than a few readers: LTX-Credence (NASDAQ: LTXC).
***Now before I go any further, I want to answer a reader email and put to rest any concerns that my company has any financial incentive for featuring a company. Wayne wrote:
"I enjoy reading your Small Cap Investor - sometimes though, I am confused about whether your recommendations, for example today's 4 contenders, are associated with companies that pay you to promote them as I have read in past letters."
I can assure all of our readers that we receive absolutely zero compensation from the companies that are featured in this letter. Let me repeat, zero compensation. I don't know what past letters Wayne is referring to, but I believe he must be talking about something different from Small Cap Investor Daily. We do occasionally run space advertisements for our advertising partners, but these are always clearly disclosed as advertisements. You'll find these are separated from the body of Small Cap Investor Daily.
So rest assured, when discussing companies in Small Cap Investor Daily, my single solitary goal is to bring profitable small cap investing opportunities to you. I'm glad Wayne wrote in with this question - now let's get back to LTX-Credence.
***As I wrote yesterday, this company develops, manufactures and markets semiconductor testing devices. I want to take a minute to talk about semiconductors.
The term semiconductor refers to a device that is the foundation of modern electronics. It is derived from polysilicon. From iPods to solar panels, nearly all modern devices rely on the silicon product. No matter what medium you’re reading today's letter on, you are using semiconductor technology. Since semiconductors are an essential component in technology, semiconductor stocks play a major role in the tech sector. If you’re bullish on tech then by default you need to be bullish on semiconductor stocks.
And I’m bullish on tech.
Why? Because the economy is in recovery mode, and consumption of tech goodies is picking up. Even if the economic recovery is more subdued than I expect it will be, there is an undeniable trend towards continued growth in the electronic gadget sector. iPods are now in the hands of one out of every two American kids and even remote regions like African countries are getting cell phones and TVs before street lights and plumbing. Honestly, this is more of a tidal wave than a mere trend.
As semiconductors are manufactured, they’re typically tested at least twice before they make their way into electronics and on to store shelves. This double-testing is done with a variety of semiconductor probing devices, pretty cool instruments that test all the semiconductors when they are in wafer form. If you've never seen one of these wafers, they look like a mini-waffle. Once they are cut up, each semiconductor moves on to fulfill its original intent in whatever device it's destined for.
This process means that any firm manufacturing semiconductors needs testing and probing equipment. And companies are always looking for ways to buy faster and better testing systems. That’s where LTX-Credence comes in.
***So let's take a closer look at this company. LTX-Credence is a $390 million market cap company providing automatic testing equipment (ATE) solutions to three different sectors - so it’s got some built-in hedge. They provide ATE for automotive and entertainment sectors, but the exciting part of their product lineup is that they’re involved in testing wireless computing wafers for the iPhone. That relationship is huge for such a small company.
The company was formed through the merger of LTX and Credence in August 2008 during a period of consolidation in the ATE sector. Since then management has been able to capitalize on cost synergies to the tune of about $112 million, as well as become the largest ATE presence in China and Taiwan.
I really like this company’s management. They had a stock issue this quarter, raising $48 million. They then used that equity to retire debt at a discount, saving about $5 million. Retiring debt is the kind of responsible corporate governance all companies should do when they raise equity, rather than just dilute existing shareholders so that management can receive fat bonuses.
This latest transaction leaves the company with only $800,000 in long-term debt, and $74 million in cash - an enviable position. If the market turns, this company has the ability to lever cash to keep its head above water. Small cap companies without cash can often face challenges, but LTXC is in good financial standing.
LTX-Credence has three main growth drivers:
1. Increase sales to existing customers
2. Poach market share in existing sectors
3. Expand into new markets.
In 2009, customers cut down on orders as a way to boost profits in the short term, and now those same customers are increasing their purchases and expanding capacity.
***To give you a sense of how the demand for LTX's services are growing, core market segments like radio frequency, power management, automotive and digital consumers grew 35% from last quarter, and are forecasted to grow another 40% next quarter. In this business, firms need to stay on the cutting edge of technology. Speed to market is paramount, and first mover advantage is critical - or company's risk becoming as obsolete as last year’s semiconductor technology. LTX-Credence is innovating, with three new product lines and the microcontroller, wafer probe and the precision analog markets are all seeing real success. With each new customer the firm signs up with these products it is taking market share directly from competitors.
Management claims that the growth strategy is a conservative one. I’d say it’s an effective one. In terms of Q3 results, revenues were up 17% from the previous quarter, and up 127% from the same fiscal quarter last year. Net income reached $6.8 million, or $0.05 a share. The company's own guidance calls for earnings per share to double to $0.10 in the fourth quarter. But the company has surprised by an average of 80% each quarter for the last year, so there is the potential that $0.10 is a conservative figure.
LTX-Credence's guidance also puts Q4 revenue at about $72 million, a 30% increase over the third quarter.
The company has a dirt cheap forward P/E of 5.7 and analysts expect earnings per share to reach $0.49 in 2011. A forward P/E of 12 is pretty conservative for the ATE sector, and valuing the company with this multiple puts fair value on shares at around $5.90, a 115 percent premium over the current share price.
Financial Times polled analysts have a 12 month median target for the stock of $5.50, more or less in line with my target.
LTX-Credence has also recently proposed a 3-to-1 reverse stock split. Regarding the reverse split, Dave Tacelli, President and CEO said “We believe this transaction will broaden LTX-Credence's appeal to institutional investors.” The stock price is well above the NASDAQ minimum listing requirement of $1.00, so I am willing to take management’s reasoning at face value. LTX-Credence has taken bold steps recently to stay competitive, and I think the reverse split is just another example of that.
***I've recently published a book, The Small Cap Investor, which clearly describes the best strategies for making profits with small-cap stocks - including how to beat institutional investors to the punch. Snapping up shares ahead of the Russell Reconstitution looks to me to be a great opportunity to do just this with LTX-Credence.
You can learn more about my strategies when you sign up for my investment advisory service, Small Cap Investor PRO. Just click here to get started today and I'll send you a free copy of my book.
Keep an eye on LTX-Credence today and tomorrow, and consider starting a position if you haven't already. Always remember to dollar cost average, and not to plow all of your available investing capital into one stock. You want to make a profit, but also be able to sleep at night.
Also, please always do your own research in addition to what I've written.
Let me know what you think of LTX-Credence, my address is: editorial@smallcapinvestor.com.
