Even by the standards of semi equipment, Teradyne (TER) has been on a tear, with the shares more than doubling over the past year (compared to the paltry nearly 70% gain at Applied Materials (AMAT) and 75% gain at ASML Holding (ASML)). Then again, with Advantest (OTCPK:ATEYY) up about 180% and FormFactor (FORM) up more than 100% as well, it’s pretty safe to say that the wafer testing market has been a good place to be, as demand from logic customers has definitely improved heading into 2020.
Sustainability and valuation were my primary concerns going into this quarter, and they remain my primary concerns. Management’s guidance suggests a year weighted to the first half, and it may well prove to be the case that 5G demand in China was artificially elevated by concerns about future restrictions on access (essentially pulling demand forward). As far as valuation goes, I know growth and momentum investors won’t care, but it’s tough to reconcile today’s price with a reasonable set of long-term growth expectations. The best I can do is to say that, within the spectrum of where semi equipment stocks trade today, the company’s valuation is not so unreasonable. Make of that what you will.
A Blowout End To The Year
Expectations rose for Teradyne throughout the year, but the company still closed on a very strong note with revenue surpassing expectations by 7% at the top line and all of the major line items beating expectations.
Revenue rose 26% yoy and more than 12% qoq, with every business growing and every business but one growing at a double-digit rate for the yoy and qoq comparisons. Gross margin declined more than a point yoy and 80bp qoq, but still beat expectations by 20bp, while operating profits rose 33% and 12%, with margin improving 160bp yoy and shrinking 10bp qoq (beating by a full point). Contained SG&A expenses were the biggest yoy margin driver, as SG&A spending increased 17% against the 26% revenue increase.
Outperformance was mixed on a yoy and qoq basis. Semi Test, the largest business by far, outperformed on a year-over-year basis (up 28%) and certainly didn’t do badly sequentially (up 10%). Wireless Test (up 13% yoy and up 6% qoq) was the only business not to grow at a double-digit sequential rate, while the Industrial Automation business (up 5% yoy and 28% qoq) was the only business not to grow at double digits on the yoy comp. Within that, Universal Robots rose 6%, while MiR rose 43%. Systems Test rose 54% yoy and 13% qoq.
Can Management Sustain The Outperformance?
Teradyne’s guidance for the first quarter was impressive, with a revenue figure that at the midpoint was 23% above the prior sell-side average target and an EPS estimate 42% above. Management also indicated, though, that while they expected a strong first half, they expected that demand to taper into the second half. With that, the post-call guidance revisions haven’t been all that significant – numbers are getting rearranged, but the totals aren’t changing so much.
Semi Test had an up-and-down year, but ended strong on 5G testing demand in China. As I said above, and as at least one analyst has mentioned in a downgrade note, it’s worth asking how much of that demand was artificially pulled forward by customer concerns over future access to testing equipment. Growth on the basis of increased handset complexity (cameras, sensors, etc.) seems more sustainable, though, and a lot of companies with meaningful exposure to handsets have been reporting better underlying trends.
Last and by no means least is share growth in the memory test business. I talked about this in that last piece, with Teradyne aiming to gain share from Advantest in high-speed memory testing on the transition to LPDDR5. That seems to be happening quickly, as management noted a 3% decline in memory sales against an estimated market decline of 35%. That would suggest that Teradyne has increased its share from roughly 30% to about 40%, with momentum heading into 2020 – a year where memory capex spending should start recovering.
Looking ahead for the Industrial Automation business, end-markets like autos and logistics/warehouse remain pressured, and the capex spending environment isn’t looking particularly robust in 2020. Teradyne should still be able to benefit from share gains and new automation adoption, though, and I expect an improved growth rate in 2020.
Discussing modeling assumptions and valuations feels almost fatuous at this point. Chip companies are certainly going to need to spend on equipment to meet growing demand in end-markets like autos, wireless, handsets, and IoT, but valuations already reflect extremely strong ramps in revenue and profits over the next few years. I believe Teradyne will generate double-digit revenue growth over the next four years, but the company has to produce an unprecedented level of revenue growth and/or margin expansion to validate today’s price on a long-term cash flow basis.
I suppose the best bullish argument for Teradyne today is that it’s a strong business with growth drivers still in place, meaning that the first and second quarters could still be better than expected, and maybe the second half won’t trail off as much. Likewise, long-term positive fundamental drivers remain in place, like healthy volume growth in chip production and rising chip complexity. Another possible argument is that, relative to other chip equipment stocks, Teradyne’s valuation is not unreasonable and, in fact, could expand on the basis of its revenue and margin expansion potential. None of that really works for me as an investor, though, so this remains a name I’d be careful with piling into at this point.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.