Our first recommendation is a tech company that is scooping up its competition and is forecast to continue growing at double-digit rates for the next few years. Our second idea is profit-taking on a company being bought out.
Buy: MKS Instruments, Inc. (MKSI)
From The Periscope Report
MKS Instruments (MKSI) acquired one of our Top Recommendations in Newport Corp. (NEWP) in April 2016 and the acquisition pushed the market cap for MKSI over $2.0 billion. Our research on MKSI intensified after the acquisition and we have concluded that MKSI presents a great opportunity for our client base.
Newport makes lasers and optic equipment that test products all along the manufacturing process to ensure they adhere to product specifications. Most of the products are made according to customer specifications, which means the customers are reliant on Newport. Thus, recurring revenue is visible thanks to tracking new orders and backlog. Newport has 20% market share. MKSI is a market leader in selling measurement and monitoring equipment to semiconductor companies with 35% market share. The combined company is a true market dominator.
The combined company will generate $130 million in Cash Flow from Operations this year and $116 million in Free Cash Flow on about $1 billion in revenue, making MKSI one of the most efficient and profitable companies, not only in its industry but across the entire spectrum of public companies. Management expects to realize $35 million in annualized cost synergies within 18 to 36 months.
The total market opportunity for MKSI is about $10 billion, and it already has at least 10% market share in all four markets. Organic growth will be 6% - 8% for the next five years. Acquisitions could add another 6% - 10% (MKSI averages at least one acquisition per year). Earnings growth will be at least 20%, which means earnings will triple within five years and so will the stock price.
Management is forecasting sales in the 3Q of 2016 to range from $345 - $385 million, and Non-GAAP net earnings to range from $0.64 - $0.86 per share, excluding acquisition costs. GAAP net earnings will range from $0.36 - $0.60 per share.
For the 2Q ended June 2016, total revenue increased 9% YoY to $359 million. This is Pro Forma results, as if Newport was included in year ago results. Net earnings increased to $0.72 per share, up from $0.62 per share a year ago, and up from $0.38 per share in the prior quarter. MKSI clobbered the mean estimate for $0.48 per share, and it was the 6th straight quarter the company has beat estimates.
The acquisition of Newport has doubled the size of the company, but it has also created a huge debt burden. Management intends to reduce debt significantly over the next three years by using its strong Cash Flow to make voluntary prepayments. We already knew Newport was a market leader in laser technology. Our research led us to the fact that MKSI had a leading position with semiconductor companies. The combined company is a market dominator, the most important trait we look for in a Top Recommendation.
Based on our Cash Flow forecasts, MKSI is undervalued. The fair value ranges from $57.39 to $66.86 per share, with a mid-point of $62, or 30% above the current stock price of $48.
MKSI has five analysts on coverage. Their mean estimate for fiscal 2016 is $2.65 per share, far below management’s guidance. The mean estimate for fiscal 2017 is $3.32 per share. Our estimates are much higher — we do not think these analysts are accounting for the strong contribution expected from Newport.
We are expecting sales to increase 72% in fiscal 2016 to $1.40 billion, which is due to the acquisition of Newport that has nearly doubled the size of the company. We are forecasting a net profit of $167.2 million, or $3.11 per share, up from $2.22 per share in 2015. Our estimates are right in line with management’s own guidance.
We are expecting sales to grow 11% in fiscal 2017 to $1.55 billion. We are forecasting net income to grow 13% to $188.3 million, or $3.49 per share. The P/E ratio on the 2017 forecast is 13.8 times, or right in line with its growth rate.
The acquisition of Newport makes MKSI a different company. It essentially doubles the sales base and the market opportunity, and significantly diversifies the business, thus reducing industry concentration and customer concentration risk. MKSI dominates four different markets and barriers to entry are high. This makes MKSI a great long-term investment.
Tom Byrne, The Periscope Report, 4025 Sunset Ridge Drive, Canyon Ferry Crossing, Helena, MT 59602, 406-465-4663, August 31, 2016