Finding value in the technology space looks incredibly hard at the moment and the tech heavy Nasdaq sits on its all-time high. In such an environment and with the bull market entering its 9th year after the Global Financial Crisis, it becomes harder and harder to find value. What I would search right now is structural growth stories with very strong market positions. I believe Teradyne (TER) fits my criteria. Structural growth is coming predominantly from exposure to robotics and to the increasing use of sophisticated microchips in many applications (automotive and assisted driving above all). At the same time, the market position appears very solid: in testing equipment, Teradyne holds approximately 50% of the market, with small market share gains over the past few years. In robotics, the company holds a 60% share of the cobots market.

Company description

First, let me give you a brief description of the markets in which the company operates: testing equipment and robotics.

On the first front, the focus is on semiconductor testing, but it also includes wireless and computer storage testing. In a nutshell, we are talking about large machines that test the functionality of hardware components for laptops and smartphones and also semiconductors for a wide variety of other applications (including the automotive sector). This explainer video from the company may help in understanding what we are talking about:

On the robotics side, the company bought Universal Robots (UR) of Denmark in 2015. Unlike traditional automation robots, UR offers collaborative robots (also known as cobots). These are much smaller than traditional robots, have force-limited joints that allow them to be operated alongside humans, are extremely flexible in performing different tasks, and can be programmed by a shop floor operator with a few easy moves. These characteristics make them affordable for small enterprises (a cobot can have a cost of around $100,000 or less rather than millions for a typical high-end robotic machine), and the payback is generally less than 12 months.

Stock performance in the last few years

I believe that looking at the chart of Teradyne shares since the financial crisis provides some very interesting information on the different growth stages:

TER data by YCharts

The first phase (20092011) coincided with the launch and extraordinary growth in the high-end smartphone market, coupled with a still decent computer equipment market. The stock quadrupled during this period. Between 2011 and 2016, shares stopped growing altogether in the context of a flat underlying market. Even though the number of smartphones and semiconductors in general increased, so did the testing capacity of the machines. This increase in equipment productivity, coupled with some in-house, cheap testing solutions developed by low-end smartphone manufacturers, led to an overall stagnant market. The third phase started in late 2016, with shares finally breaking out of the range and the company beating earnings and raising guidance more than once. This may just be the beginning, and several growth drivers seem to be supporting the trend.

The growth drivers

First of all, we have some rapidly expanding markets. Automotive is a very interesting growth story. Microchips used in the auto industry need to go through very extensive testing due to the high performance and extended lifespan required. At the same time, cars are becoming more and more connected (think assisted/autonomous driving and electric vehicles), with many high-end electronic and computer-based options now becoming widely available on low cost/high volume models. The slide below, from a recent Infineon (OTCQX:IFNNF) presentation, shows the range of sensors that are currently marketed in the automotive division and how their presence will dramatically increase over the next few years:

Source: Infineon investor presentation June 2017

Another factor to take into consideration is the ever-increasing complexity of app processors. Added complexity means extended testing times and a reduction in the productivity gains that prevented the testing equipment market from growing over the past few years (more limited parallel testing potential).

The third growth driver can be found in robotics and the increasing range of applications for cobots. This market is currently very small (around $200 mln worldwide) but growing at around 50% per annum and expected to grow at similar levels over the next few years. I am always skeptical about these very high growth markets as I remember the disaster in 3D printing stocks. Here is what I like about this sector: there is a much broader range of applications for all sorts of industries, a simple setup process but, most importantly, a very clear and easy to measure payback period, as cobots substitute manual work. I also like Universal Robots dominant market share in cobots (around 60%), a market that they effectively invented. But more importantly, UR is aggressively working on the creation of a broad ecosystem of third party hardware and software to adapt cobots to perform more and more industry specific tasks and is rapidly expanding its global distribution network. I believe these efforts will help the company maintain a solid position in a rapidly expanding market.

The financials and valuation

In the most recent quarter, Teradyne announced results that beat guidance and expectations and provided guidance for the second quarter that was higher than consensus. The company also increased its view on the size of the overall market for testing equipment even from its recent January estimate. What I find particularly encouraging is the breadth of the revenue/orders beat with automotive, mobility, image sensor, and memory all driving orders higher in the quarter and Universal Robots increasing sales 117% yoy. Surely, Universal Robots still represents a small part of the business (around 8% of total sales in Q1), but with sales growth of 117% yoy in the quarter and new orders up 150% yoy, we can expect this division to become sizable and soon capable of moving the needle.

The company has plenty of liquidity, with net cash of more than $1 bn (17% of the market cap) on the balance sheet and a plan to distribute more than $250 mln during 2017 through dividends and buybacks. From a valuation perspective, the stock is trading on 15.7x consensus 2017 earnings. This is not significantly above the average forward P/E of the past few years even though growth expectations have increased over the last 12 months.

Conclusions

Over the past 12 months, the stock appreciated significantly and is up roughly 50%. I generally find it very difficult to recommend an investment in a stock that has already seen such a significant growth, and, to be honest, I wish I discovered Teradyne earlier. That said, Teradyne still trades at a significant discount to Nasdaq on consensus P/E (15.7x vs. 19.5x) despite clear signs that we may be close to a shift in growth expectations in the industry. Risks are those typical of high growth technology industries, with price deflation and an increasing competition in robotics being the most significant. However, I believe the solid level of market share in both semi test equipment (50%) and cobots (60%) will certainly help Teradyne reap the benefits of a re-acceleration in growth that doesn't seem to be fully appreciated by investors.

Disclosure: I am/we are long TER.

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.

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Teradyne: Robotics And Assisted Driving Will Drive Growth - Seeking Alpha