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Cohu’s testing services are worth their weight in gold, but credit markets don’t see the value

Similar to oil prices, semiconductors have become very important to the global economy. Today’s FA Alpha Daily will key in on Cohu, Inc. (COHU), one of the industry leaders in testing the wafers that make chips, and how credit agencies are missing this tailwind.

FA Alpha Daily:
Wednesday Credit
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Last week we talked about the important role oil continues to play in the global economy. It still holds the title as the most important commodity in the world of the current era, and its fluctuations have the ability to drastically tilt the direction of the economy.

However, just as data has become the new currency, there is another kind of commodity that has quickly become a key component of the world economy over the past 12+ months. Granted this isn’t a commodity like oil, but it can clearly make an economy hum or not, just like oil.

This commodity is semiconductors.

With the shift in how we operate as a global economy today, it seems that we are increasingly wired into everything.

As a result, a lack of semiconductors of any type can throw the global economy off-kilter. Just as important is making sure that once these semiconductors have been made, they are working properly.

To test whether a wafer’s chips are working as they should, if they are defective, or even if they have had small errors that make them fail down the line can all lead to millions of dollars if not more in losses for companies.

As you might imagine, the suppliers of these testing equipment companies have seen a boom in demand, and one of them is Cohu (COHU).

And yet, amidst all of this booming demand, the company is still rated by S&P as though it’s at imminent default risk. They have given the company a B+ rating which signifies that they believe there’s a 25% chance it goes bankrupt within the next four years.

However, we can figure out the true risk by examining it through the lens of Credit Cash Flow Prime.

In the chart below, the stacked bars represent the firm’s obligations each year for the next seven years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

Even if we were unaware of the massive tailwinds for the company and industry that would make this default unlikely, a look at the CCFP shows why that makes no sense.

Not only does Cohu have strong cash flows that exceed operating obligations for the next five years, but it also has ample cash buffers on hand, including its debt maturities in 2025. Combined, we are left with a company that is facing a very low risk of bankruptcy and has a significant buffer even if there were a minor disruption at any time.

See for yourself:

S&P’s B+ credit rating isn’t reflective of Cohu’s creditworthiness, but rather a sign of the rating agencies missing the company’s tailwinds.

That’s why we rate Cohu as a much safer IG4+ investment-grade credit, and with the continued fundamental tailwinds, could be even stronger.

Cohu is yet another company where the credit rating agencies don’t capture the complete story. While we at Valens recognize the flaws with traditional credit ratings, many creditors do not. The B+ credit rating is pessimistic and paints a picture of a company that is much riskier than it is in reality.

It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.

To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.

SUMMARY and Cohu, Inc. Tearsheet

As the Uniform Accounting tearsheet for Cohu, Inc. (COHU:USA) highlights, the Uniform P/E trades at 11.1x, which is below the global corporate average of 24.0x and its historical P/E of 13.4x.

Low P/Es require low EPS growth to sustain them. That said, in the case of Cohu, the company has recently shown a 70% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Cohu’s Wall Street analyst-driven forecast is for a 20% decline in 2022 and a 17% growth in 2023.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Cohu’s $28 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink by 13% over the next three years. What Wall Street analysts expect for Cohu’s earnings growth is below what the current stock market valuation requires in 2022, but above the requirement in 2023.

Furthermore, the company’s earning power in 2021 is 4x above the long-run corporate average. Moreover, cash flows and cash on hand are 4x its total obligations—including debt maturities and capex maintenance. However, intrinsic credit risk is 130bps above the risk-free rate. All in all, this signals a moderate credit risk.

Lastly, Cohu’s Uniform earnings growth is well below its peer averages, and the company is trading below its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

This analysis of Cohu, Inc. (COHU) credit outlook is the same type of analysis that powers our macro research detailed in the FA Alpha Pulse.

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