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Teradyne (NASDAQ:TER) Reports Weak Q4, Stock Drops


Full Report / January 30, 2024

Semiconductor testing company Teradyne (NASDAQ:TER) missed analysts' expectations in Q4 FY2023, with revenue down 8.4% year on year to $670.6 million. Next quarter's revenue guidance of $565 million also underwhelmed, coming in 9.6% below analysts' estimates. It made a non-GAAP profit of $0.79 per share, down from its profit of $0.92 per share in the same quarter last year.

Teradyne (TER) Q4 FY2023 Highlights:

  • Market Capitalization: $16.22 billion
  • Revenue: $670.6 million vs analyst estimates of $677 million (0.9% miss)
  • EPS (non-GAAP): $0.79 vs analyst estimates of $0.72 (10% beat)
  • Revenue Guidance for Q1 2024 is $565 million at the midpoint, well below analyst estimates of $624.7 million (EPS guidance also well below)
  • Free Cash Flow of $204.4 million, up 46.3% from the previous quarter
  • Inventory Days Outstanding: 2, down from 96 in the previous quarter
  • Gross Margin (GAAP): 56.6%, down from 57.5% in the same quarter last year

Sporting most major chip manufacturers as its customers, Teradyne (NASDAQ:TER) is a US-based supplier of automated test equipment for semiconductors as well as other technologies and devices.

Teradyne (NASDAQ:TER) was founded in 1960 by MIT classmates Alex d'Arbeloff and Nick DeWolf and remains headquartered in Massachusetts. The company went public on the NYSE in 1970.

Throughout the semiconductor manufacturing process, chips need to be tested to ensure they comply with accepted industry standards and are accurate and functional. Since semiconductor manufacturing is a complex and resource-intensive process, detecting flaws early in the process means saving money and time.

Historically, much of the testing was performed manually, leading to bottlenecks. Teradyne speeds testing up through automation, and their testing products range from simple, single digital measurement devices to complicated systems containing multiple instruments that automatically reveal faults on wafers or in packaged parts. This automation ensures quality control while increasing speed to market and improving production yields.

In addition to automated semiconductor testing equipment, Teradyne systems are also used to ensure the readiness of aerospace electronics systems, such as tactical aircraft and missile systems. The company also provides solutions for testing the reliability of hard drives and Wi-Fi, Bluetooth and cellular chips.

Competitors in automated testing equipment include Advantest Corporation (TSE:6857), Cohu (NASDAQ:COHU), Keysight Technologies (NYSE:KEYS), and Rohde & Schwarz.

Sales Growth

Teradyne's revenue has been declining over the last three years, dropping by 3.6% on average per year. This quarter, its revenue declined from $731.8 million in the same quarter last year to $670.6 million. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

Teradyne Total Revenue

Teradyne had a difficult quarter as revenue dropped 8.4% year on year, missing analysts' estimates by 0.9%. This could mean that the current downcycle is deepening.

Teradyne may be headed for an upturn. Although the company is guiding for a year-on-year revenue decline of 8.5% next quarter, analysts are expecting revenue to grow 11.1% over the next 12 months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.

Teradyne Inventory Days Outstanding

This quarter, Teradyne's DIO came in at 2, which is 68 days below its five-year average. At the moment, these numbers show no indication of an excessive inventory buildup.

Pricing Power

In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Teradyne's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 56.6% in Q4, down 0.9 percentage points year on year.

Teradyne Gross Margin (GAAP)

Despite declining over the last 12 months, Teradyne still retains reasonably high gross margins, averaging 57.4%. These margins point to its solid competitive offering, disciplined cost controls, and lack of significant pricing pressure.

Profitability

Teradyne reported an operating margin of 19% in Q4, down 4.1 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.

Teradyne Adjusted Operating Margin

Teradyne's operating margins have been trending down over the last year, averaging 20.1%. This is a bad sign for Teradyne, whose margins are already below average for semiconductor companies. To its credit, however, the company's margins suggest modest pricing power and cost controls.

Earnings, Cash & Competitive Moat

Analysts covering Teradyne expect earnings per share to grow 20.6% over the next 12 months, although estimates will likely change after earnings.

Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Teradyne's free cash flow came in at $204.4 million in Q4, up 37.4% year on year.

Teradyne Free Cash Flow

As you can see above, Teradyne produced free cash flow of $425.6 million in the last year, a decent 15.5% of revenue. This FCF margin puts Teradyne in a position to reinvest, but we wouldn't mind seeing its cash flow conversion improve a little.

Return on Invested Capital (ROIC)

EPS growth informs us whether a company's revenue growth was profitable. But was it capital-efficient? For example, if two companies had the same EPS growth, we’d prefer the one putting up those numbers with lower capital requirements (usually in the form of balance sheet debt and equity).

Enter ROIC, a pivotal metric showing how much operating profit a company generates relative to the capital it's invested in the business. ROIC not only gauges a company's ability to grow profits but also sheds light on a management team's ability to allocate its limited resources.

Teradyne's five-year average ROIC was 57.5%, placing it among the best semiconductor companies. Just as you’d like your investment dollars to generate returns, Teradyne's invested capital has produced excellent profits. The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, Teradyne's ROIC has averaged 34.2 percentage point decreases each year. We still think Teradyne is a good business, but if its returns keep falling, it could suggest its competitive advantage or profitable investment opportunities are shrinking. We'll keep a close eye on the company.

Key Takeaways from Teradyne's Q4 Results

We were impressed by Teradyne's strong improvement in inventory levels. We were also excited its EPS outperformed Wall Street's estimates. However, revenue missed. Also, the company's revenue and EPS guidance for next quarter both missed analysts' expectations by a large amount. Management explained this, saying "Looking into the new year, we expect low tester utilization will impact demand in the first half of the year." Overall, this was a mixed quarter for Teradyne with guidance that was particularly bad. The company is down 6.7% on the results and currently trades at $97.5 per share.

Is Now The Time?

Teradyne may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We think Teradyne is a solid business. Although its revenue growth has been poor over the last three years with analysts expecting growth to slow from here, its stellar ROIC suggests it has been a well-run company historically. And while its operating margins are below average compared to its semiconductor peers, its gross margins are suggestive of good pricing power.

Teradyne's price-to-earnings ratio based on the next 12 months is 29.1x. There are definitely things to like about Teradyne and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.

Wall Street analysts covering the company had a one-year price target of $113.3 per share right before these results (compared to the current share price of $97.5), implying they saw upside in buying Teradyne in the short term.

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