Monday, August 29, 2011

FEI Company Casts a Wider Net

FEI Company (FEIC) reported show stopping numbers the past nine months. Three picture perfect quarters. Sitting high on top of the organizational chart is CEO Don Kania, and he sets the record straight in the August 2nd, 2011, Q2 Conference Call: "We delivered record revenue and earnings for the third quarter in a row...(the most recent one being) the second highest in our history and the highest ever for second quarter with 17% year-over-year growth...".

Investors have taken notice and elevated FEI to its 52 week high of $41 on July 7th, but have since gotten cold feet and stopped it in its tracks, pushing it back to the $33 range where it currently trades. This decrease in price coincided with the general market sell-off which began in the second week of July. It's a solid company with a compelling story, and, if you bought the equity at the 52 week low of $16.50, you're in great shape. You have a double. Market participants with a long term perspective may be rewarded handsomely with a stake in FEI Company. With investors giving the stock the treatment, you may even consider buying the company now, but, before you do, let's look at the overall picture and see what you think.

FEI Company primarily manufactures microscopes for use in nanotechnology. As the most recent 10-K states: "We are a leading supplier of instruments for nanoscale imaging, analysis and prototyping to enable research, development and manufacturing in a range of industrial, academic and research institutional applications.". CEO Kania expounds upon the future in the Q1 Conference Call: "Looking forward, prospects remain good as the technical demands of shrinking devices continues to increase...". Think Moore's Law where the number of transistors that can be placed inexpensively on an integrated circuit doubles approximately every two years.

The organization has four product segments which are: Electronics (35%), Life Sciences (12%), Research and Industry (29%), and, Services and Components (24%). It has sales and operations in 50 countries around the world of which 68% of revenues come from abroad. The R&D budget is healthy, and plans for expansion address the potential increase in market share. CEO Kania explains this in the Q2 Conference Call: "As the year progresses, we expect R&D spending to expand to our target of 11%. We believe this level of spending is matched to our strategy to double our served available market by 2014.".

Doubling your market in three years is a hefty goal, but in the past five years, FEI Company has done an impressive job of broadening their customer base to industries beyond their previous core competency. Portland Business Journal writer Erik Siemers reflects upon this in his May, 20th, 2011 article Hillsboros'a FEI Busts Boundries: "FEI - whose microscopes average $1 million in price but can go as high as $6 million - was once heavily reliant upon the the semiconductor manufacturing market. As recently as 2004, the company's sales were split evenly between semiconductor manufacturers and research institutions, with a sliver going to customers in the data storage industry. Over the past five years in particular, the company has successfully penetrated new markets including life sciences and heavy industries such as mining, automotive and aerospace manufacturing.".

The article goes on to say that: "Its next target is the oil and gas market...FEI's technology can examine pieces of rock from a mine or oil well to discover its exact mineral content. That can help operators decide weather they've drilled far enough...In an industry that spends several billion dollars each year exploring for natural resources, the opportunity for FEI is plentiful. In a way, it could be the microscopy industry's equivalent to a gold rush.".

FEI isn't part of the old-boy network, but they have been around since 1971, and, went public in 1995. This is a company with good DNA. I examined their numbers going back to 2001, and, sure enough, it's been a history of boom and bust cycles. Earnings appear to be on a linear rise the past few years, albeit lumpy on both an annual and quarterly basis. However, this is an old pattern for them and, as a result, the security keeps getting tripped up once the market gets wind of inconsistent earnings results.

Their Achilles' heel was once being a prisoner to the ebbs and flows of the semiconductor cycle, but they are still subject to the seasonality of the technology sector. As the 10-K points out: "Our history shows that our revenues and bookings normally peak in the fourth quarter. Bookings are normally lowest in the second quarter and revenues are normally lowest in the third quarter...". They are currently in the third quarter and this may mean more pressure on the share price.

Although they've established a beachhead in additional industries like oil and gas exploration, you may be still be paying a price premium for FEI Company. At least in the near-term. As CEO Kania explains in the Q2 Conference Call: "...we are prudently planning for Electronics orders to be down in the third quarter. Based on discussions with customers, we expect the rebound in the fourth quarter as substantial technology challenges continue to face the industry.".

The company's P/E Ratio for 2011 is 14.35 which is historically low for FEI. Since 2006, the average annual P/E Ratio has been close to 30, except for last year when it was 17. Yahoo Finance consensus analyst estimates doesn't have much information available in regards to current or projected earnings. I used ValueLine metrics for most of my calculations. Yahoo Finance does state that on a five year compound annual growth rate, FEI Company is slated to grow at 11.67%, and, revenue is going to grow from $824 million in 2011 to $870 million in 2012. That's under 10%.

Going back to ValueLine, they believe that for 2012, top-line growth will be only 5% and earnings will come in at a pace of 9%. That's fairly close to the Yahoo Finance estimates. ValueLine is also concerned with the health of the global economy and FEI's symbiotic relationship with the semiconductor industry. This may put a damper on share appreciation for the next twelve months. I concur with their assessment, but not without some reservations.

In my personal portfolio, I believe the financial markets are on life-support, so I've remained short, or, in cash positions for the last year and a half. However, if I am wrong, and, other naysayers are wrong, then organizations like FEI Company could make you a boatload of money. The profits may be mind boggling. The market has been fascinating theater of late with a global recession looming and governments worldwide putting their fingers in the dikes. However, if we do get a continued rebound in the indexes, then in the short-term, a company like FEI would be the way to go. If history is any indication, they should have a terrific 4th quarter.