INTT inTest Corporation

Wake Up, This Stock is Under-Valued!

Ken Nagy, CFA

On November 2, 2011, inTest Corporation (INTT), an independent designer, manufacturer and marketer of semiconductor automatic test equipment interface solutions and temperature management products, reported financial results for its fiscal 2011 third quarter and nine months, ended September 30, 2011.

A solid third quarter by the Company resulted in quarterly revenues increasing by 3.3 percent or $376,000 year over year to $11.681 million, which compares to revenues of $11.305 million for the three months ended September 30, 2010.

inTest  reported that third quarter bookings were $10.5 million, down from  its second quarter 2011 bookings of $13.5 million but up year over year compared to its third quarter 2010 bookings of $9.8 million.

inTest’s third quarter 2011 net income soared  $3.504 million to $5.182 million from $1.678 million during the three months ended September 30, 2010. Still, third quarter net earnings per share would have resulted in $0.22 per diluted share absent the valuation allowance as the impact of the reversal of the valuation allowance increased diluted net earnings per share by $0.28 per diluted share.

The jump in year over year net income was primarily due to improved gross margin as well as a reversal of the valuation allowance against deferred tax assets resulting in an income tax benefit of $2.762 million in the third quarter of 2011 compared to an income tax expense of $16,000 for the comparable quarter of 2010.

Gross margin increased year over year from 48.2 percent to 52.5 percent for the three months ended September 30, 2011.The increase in gross margin was mainly due to a more favorable product mix in the Company’s Mechanical Products segment.

Based on a weighted average number of diluted shares outstanding of 10.297 million, diluted net income per share resulted in $0.50 per share.  This compared to diluted net income per share of $0.17 on a weighted average number of diluted shares of 10.195 million during the three months ended September 30, 2010.

inTest’s balance sheet continued to improve with cash and equivalents increasing sequentially by $3.185 million to $12.064 million and working capital improving by $3.007 million to $18.618 million for the period ended September 30, 2011.

The increase in cash was due to strong cash collections during the third quarter and management predicts that cash will increase to between $14 to $15 million by December 31, 2011.

Similarly, total stockholder’s equity improved sequentially by over 25 percent or $5.146 million to $25.441 million.

Additionally, management reported that it anticipates net revenue for its fourth quarter ended December 31, 2011 will be in the range of $9.5 million to $10.5 million and that net earnings will be in the range of $0.03 to $0.10 per diluted share.

The Company further believes that the diversification of its served markets via its thermal group, improved efficiency and reduced operating costs attributable to its relocation of facilities are all strengths it can leverage moving forward. Along the same lines the Company continues to expand upon its diversification strategy by leveraging its thermal division and Sigma Systems acquisition.

inTest believes it continues to make significant process in diversifying its end market penetration through its thermal products  which offer an effective way to expand the Company’s available markets by acquiring non semiconductor business in the aerospace, automotive, medical and telecommunications markets.

As a result of this diversification strategy, non-semi related bookings consisted of 18 percent of the Company’s consolidated bookings at the beginning of the year which compares to third quarter non-semi bookings comprising  of 41 percent of inTest’s consolidated bookings.

The Company expects this trend to continue and predicts that non semiconductor related products will play an even greater role in company’s success going forward.

 

The firm has a diversified portfolio that includes non-semiconductor markets. This revenue should be a bit more inelastic and run on a different cyclical time frame than the semiconductor business. The firm’s goal is to grow Non-Semi revenue to 50% of revenue.  The potential for Non-Semi is enormous because it incorporates any market that uses thermal.  We value the firm using several metrics

Enterprise Multiple

The enterprise multiple looks at a firm as a potential acquirer would. The ratio takes debt into account, which is an item which other multiples do not include. Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents. The Firm’s Enterprise multiple is 2.54x compared to 4.79x for the industry. According to the enterprise multiple INTT appears undervalued compared to industry.

 

Two Stage Free Cash Flow to Equity Model

FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment 

Assumptions

•  The firm is expected to grow at a higher growth rate in the first period.

• The growth rate will drop at the end of the first period to the stable growth rate.

• The free cash flow to equity is the correct measure of expected cash flows to stockholders. (rather than dividends)

Rationale for using the Model

As the non-semiconductor business ramps up to 50% of total revenues we expect the firm to grow at a higher overall rate than the industry.  As These products mature and the firm faces more competition we expect the growth rate to level off.

Weakness of the Model

As you add more layers to the model it is more sensitive to the assumptions you make. The growth may look more “lumpy” than we have it in the model.

Output

We used the following inputs:

•     A 5-year period with an earnings growth rate of 8.0% and a discount rate of 13.77%.

 

•     A continuing period assumed to go on forever, with earnings growing at 6% and a discount rate of 13.05%.

With these inputs we arrive at a target price of $7.23.

According to the model, the firm appears undervalued.

 Price to Earnings Multiples/ Price to Sales Multiples

Due to its simplicity the Price/Earnings ratio is easily the most widely used metric in all of finance. The first strength of the model is that it is intuitive. It is simply the price paid for current earnings. It can also act as a proxy for other firm characteristics such as risk and growth. There is a downside to the P/E ratio in that it has the potential to reflect investor’s mood rather than the fundamentals of the firm. It also eliminates assumptions about risk, growth, and retention ratio (something discounted cash flow models account for.)  

While not as popular as Price/Earnings or Price/BV, Price/Sales is not influenced by accounting decisions in depreciation, inventory and extraordinary charges. P/S multiples are much less volatile than P/E multiples. However if the problem with the firm lies in cost control the P/S ratio will not reflect this flaw.

The firm appears undervalued compared to the industry.

 

*source for background and General information on valuation models: Investment Valuation, Aswath Damodaran

Our price target of $7.00 per share is the average of 10.1x our 2011 EPS estimate and our two stage model. We would add shares at these levels.  

 

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