Are small-cap semiconductors like BHE a smart bargain?

January 14, 2019

Are small-cap semiconductors like BHE a smart bargain?

Over the last couple of days, I’ve highlighted a couple of the biggest players in the Electronic Equipment industry that supplies the entire Technology sector. I think it’s always interesting, and useful to pay attention to the industries that supply a sector with the materials, services, and manufacturing or fabrication services it relies on. Since I also consider something of a techno-nerd, that also means that stocks like KLAC, LRCX, and today’s spotlight, Benchmark Electronics Inc. (BHE) are almost always going to pique my interest.

Tech stocks, and semiconductors in particular led the market throughout the duration of its bullish run beginning in late 2009 and running up until the end of last year. For a lot of investors, this was the sector where there was easy money to be found, and it seemed like if there was a “can’t-miss” way to play the stock market, it was in these stocks. It shouldn’t really be all that surprising, then to say that for the last year, and since September in particular, tech and semi stocks have both significantly underperformed the market as uncertainty swirled around the sector. Tariffs, declining demand amid increasing supply, and increasing competitive pressures have all played a role in dampening investor’s enthusiasm for the sector for most of the past year.

The sector’s general decline – which for the Technology sector, is a little shy of -15% since September, and for Semiconductors is a little over -17% since March of 2018 – is something that has pushed a lot of stocks down to individual bear market levels. BHE, for example is down about -35% since it reached a high at around $33 in March of last year, at the same time the Semiconductor industry peaked. In an of itself, that is something that should make any bargain-hunting investor start to sit up and pay a little more attention; but the thing you have to look out for with stocks at these levels is buying into the idea that the stock is a great value just because it is down big. Sometimes, a cheap stock is just a cheap stock, which means that buying it at a low price relative to recent history could just get you into a losing situation that will only just get worse.

My answer to that concern revolves around fundamental and valuation analysis. When an entire sector is down, you can expect practically all of the stocks in the sector to feel the pain; that is as true of the strongest and most stable companies as it is of the ones that are actually struggling. If you can find the stocks in the sector that have solid fundamentals to indicate a stable business with the ability to weather the storm that comes during a bear market, along with an interesting value proposition, then you usually have a pretty good recipe for a solid long-term investment.

It’s pretty easy to gravitate to the largest, most recognizable and best-established names in a sector or industry; they usually have the best fundamentals, and are the most likely to still be standing strong when the dust from a bear market clears. That doesn’t mean, however that there aren’t some good opportunities to be found among those companies’ smaller competitors; in fact, if I can find a small-cap stock that fits the kind of fundamental strength requirements I look for, and looks like a good bargain to boot, the long-term opportunity in that stock could be much better than what will be found amongst the industry’s “big boys.” Does BHE fit that category? Let’s find out.

Fundamental and Value Profile

Benchmark Electronics, Inc. is a provider of electronic manufacturing services. The Company operates through three segments: the Americas, Asia and Europe. It provides services to original equipment manufacturers of industrial control equipment, including equipment for the aerospace and defense industry; telecommunication equipment; computers and related products for business enterprises; medical devices, and testing and instrumentation products. It offers integrated design and manufacturing services. Its operations consist of over three principal areas: manufacturing and assembly operations, including printed circuit boards assemblies and subsystem assembly, box build and systems integration; precision technology manufacturing, which include precision machining, metal joining, assembly and functional testing, and specialized engineering services, and specialized engineering services, such as product design, printed circuit board layout, prototyping, automation and test development. BHE’s current market cap is $1 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings declined by a little over -15% while revenues increased about 6%. In the last quarter, earnings increased 10%, while revenues declined by -3%. BHE’s margin profile raises a pretty big red flag, since over the last twelve months the Net Income was -3.14% of Revenues. That number was positive in the last quarter, but still indicated a very narrow margin profile, at only 1.2%. BHE reported negative Net Income in each quarter of 2018; but even prior to that, the company showed a very narrow margin profile that was consistently less than 5%.
  • Free Cash Flow: BHE’s free cash flow is negative, which isn’t surprising given the information I just shared about Net Income. Over the last twelve months, BHE reported about -$31 million in Free Cash Flow.
  • Debt to Equity: BHE has a debt/equity ratio of .12. This is one of the stock’s biggest strengths, since long-term debt is very low, and only $149.34 million in the last quarter against $475.71 in cash and liquid assets. I should note here, however that the while the company’s liquidity is very healthy, it has declined by nearly -30% over the last two years, when they reported nearly $680 million in cash at the end of the first quarter of 2017.
  • Dividend: BHE pays an annual dividend of $.60 per share, which translates to a yield of about 2.59% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for BHE is $25.80 and translates to a Price/Book ratio of .89 at the stock’s current price. As a value investor, I do like it when I can find a stock that is trading below its Book Value, and the truth is that this is something that just doesn’t happen very often with tech stocks. However, in BHE’s case, that doesn’t automatically translate to a big opportunity; the stock’s historical Price/Book ratio is only .96, which is only a little over 7% away from the stock’s current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from March 2018 to the pivot low, and the 52-week low it reached at the end of the year; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. Despite the stock’s rally so far this year, the stock is a little under 10% below the resistance shown by the 38.2% retracement line at about $25 per share. The strength of the downward trend does imply the stock is more likely to find resistance somewhere between its current price and that retracement line than it is to keep building bullish momentum. That resistance looks to be anywhere between $24 and $25 per share. The stock would need to break above $25 to offer any kind of sustainable upward trend, and an actual reversal of the long-term downward trend isn’t likely to be seen unless, and until the stock breaks above $26.50 per share, as shown by the 50% retracement line. If the stock breaks below its recent trend low around $20, its next support point could be in the $16 to $17 range based on previous price pivots as far back as 2012.

Near-term Keys: If you’re looking for a short-term bullish trade, this is a stock that doesn’t really offer a good enough reward: risk ratio to justify the low probability of success right now. That could change if the stock breaks above $25, but any kind of swing or momentum-based trade before that point with call options or buying the stock outright would be sheer speculation. I’m not entirely sure the stock is at a big risk to drop below $20, and the truth is that another dip near to that multi-year low could offer a pretty nice price at that point based strictly off of its historical Price/Book ratio. I don’t love this stock at its current price, however, and the stock’s fundamentals are troubling enough that I would have a hard time justifying a position even at that price. The smarter play in this case would be to come back to the stock in a quarter or two to see if the stock’s fundamentals are improving, and if they are, to re-evaluate the value proposition at that point.