Last Tuesday, author Jack Hough of Barron’s commented that one small-cap chip stock had a 50% potential upside. That chip stock is Photronics, Inc. (NASDAQ:PLAB), a photomasks manufacturer. Since the beginning of the year, Photronics has experienced a decent gain of 8.7%. Should investors be bullish about Photronics at its current trading price? Let’s find out.
Large customer concentration
Photronics, Inc. (NASDAQ:PLAB), organized in 1969, is one of the global leading maker of photomasks, a key element in the fabrication of integrated circuits and flat panel displays, operating eight manufacturing facilities located in Europe, Taiwan, Korea and the U.S. The majority of its revenue, $350.1 million, or 77.7% of the total 2012 revenue, was generated via its products for integrated circuits while the sales for flat panel displays fabrication were $100 million in 2012 revenue. In terms of geographic area, Korea is the biggest revenue source, with $161.1 million in revenue. The U.S. ranked second with $135.2 million in sales. Taiwan and Europe contributed $109.2 million and $40.7 million in 2012 revenue, respectively. The company has quite a customer concentration. With 600 customers globally, Samsung Electronics Co., Ltd. (KRX:005930) is the largest customer, accounting for 22% of the total sales in 2012. Its five largest customers represented around 43% of 2012 revenue.
Slow revenue growth but consistent positive cash flow
In the past five years, Photronics, Inc. (NASDAQ:PLAB) hasn’t experienced good growth in its top line, climbing from $423 million in 2008 to only $450 million in 2012 while the net income shot up from the loss of $211 million to a profit of $28 million during the same period. A huge loss incurred in 2008 was due to significant charges of more than $200 million in goodwill and long-lived assets. Thus, as they were non-cash charges, the operating cash flow was still positive and on the rise, from $92 million in 2008 to $133 million in 2012. The free cash flow also rose from -$13 million to $36 million in the same period. What makes me interested is the fact that Photronics has a conservative capital structure. As of Jan 2013, it had $563 million in total stockholders’ equity, $218 million in cash and only $175 million in both long and short-term debt.
Jack Hough of Barron’s wrote that according to JPMorgan Chase & Co. (NYSE:JPM), the company has been increasing its market share compared to larger Japanese peers including DAI NIPPON PRINTING (NASDAQOTH:DNPCF). Interestingly,
nine suppliers for Apple’s iPhone 5 were Photronics’ customers. Intel Corporation (NASDAQ:INTC) is also one of Photronics’ customers. The agreement of the two companies dated back to September 2009. Both companies agreed to work together to share technical and operations information of Photronic’s mask manufacturing lines, and the alignment of mask making toolsets of the two companies. As Intel has cut back its inventory recently, from $5.3 billion in Sept 2012 to $4.73 billion in Dec 2012, it would reduce its production level. Thus, the sales of Photronics to Intel Corporation (NASDAQ:INTC) will be impacted somewhat.
Peer comparison
DAI NIPPON PRINTING (NASDAQOTH:DNPCF), at $9.70 per share, has a total market cap of around $6.25 billion. It is valued quite cheaply, at only 3.64 times EV/EBITDA. However, it is still more expensive than Photronics as it has an EV multiple of only 3. With $7 per share, Photronics is worth only $425 million on the market.
In terms of profitability, Photronics seems to be more profitable than DAI NIPPON PRINTING (NASDAQOTH:DNPCF) with higher operating margin and return on equity. While Photronics generated a 9.4% operating margin and a 4.8% return on equity, Dai Nippon Printing had only a 2.35% operating margin and a negative return on equity of -1.3%.
The Foolish take
Photronics seems to be a decent pick at its current trading price due to its strong balance sheet, high operating margin, and low valuation. However, I do not think Photronics could be a stock for the long run due to its customer concentration. Although most of Photronics’ customers are big companies, a cutback in orders of one customer might affect Photronics’ operating performance significantly.
Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel.
