The big upswing in the market has swept up many high-quality names and taken a lot of value with it, including the shares of nanoscale microscopy specialist FEI (Nasdaq:FEIC). Fast-growing new markets and a recovery in the semiconductor industry offer significant long-term revenue generation opportunities, but order patterns can be lumpy. While not an obvious bargain today, these shares are nevertheless worth watching by investors looking for an analytical instruments company with broad industry exposure.
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Good Performance in a Challenging Environment
Against the broader industry of analytical tools, FEI Company did pretty well for the final quarter of 2012. Revenue rose 8% as reported, and 6% on an organic basis, which was slightly better than analysts had expected. Sales in the material sciences category led the way with 38% growth, while electronics saw 4% growth. Service revenue was up 8.91%, but sales in the life sciences category fell 21%.
FEI continues to deliver improving margin performance. Gross margin expanded nearly three points in the fourth quarter versus a year ago. Operating income was a little more convoluted due to some restructuring charges, but adjusted earnings grew 21% and the corresponding margin improved by almost two points despite a double-digit increase in R&D expense.
SEE: R&D Spending And Profitability: What's The Link?
Comps and Outlook a Little Convoluted
On balance, FEI did well this quarter in the analytical tools sector. The double-digit decline in life sciences was admittedly a little disappointing, as companies like Waters (NYSE:WAT) and Thermo Fisher Scientific (NYSE:TMO) squeezed out a little organic growth. But including other names like Danaher (NYSE:DHR) and Mettler-Toledo (NYSE:MTD) into a broader set of comparables and looking at the overall performance suggests that FEI is doing all right.
Business is also looking relatively stable in the near term. Bookings increased 13% this quarter, and while the growth rate of orders exceeded the revenue growth rate, the company had another quarter with a book-to-bill ratio of 1. That said, there were significant moving parts to the number. Material sciences orders jumped 38% versus a year ago, and the company continues to see strong interest in the natural resources industry. While sales were soft this quarter, life science bookings were quite strong (up 34%) and particularly so in structural biology.
Year-over-year electronics orders were down 31%, and that may be the biggest unknown for 2013. Samsung (OTC:SSNLF), Intel (Nasdaq:INTC) and Taiwan Semiconductor (NYSE:TSM) continue to try to find that sweet spot between investing for the future and preserving capital and margins in an environment that is still fairly unimpressive for chip companies. Although the long-term trends in chip manufacturing (smaller, more complex) definitely favor FEI's products, the path to further penetrating and growing this market will never be straight.
SEE: The Industry Handbook: The Semiconductor Industry
Ample Opportunities Argue for a Long-Term Perspective
With a strong share in transmission electron microscope and dual-beam systems (combining scanning electron microscopy with fixed-ion beam), FEI looks to be in a good position to enjoy growing markets in material and life sciences.
Mining companies can use this equipment to identify the most promising ore veins to exploit and/or optimize the crush ratios, while oil/gas companies can use them to assess porosity and make better drilling decisions. With the cost of new mines increasing significantly (and CEOs increasingly called out on their prior capital allocation decisions) and new wells costing upwards of $10 million, maximizing the impact of E&P budgets argues for FEI's equipment, and this could become a half-billion-dollar market in only a few years.
The potential in life sciences could be even more significant down the line, as FEI's equipment facilitates proteomics, a rapidly-growing segment of research and drug development. Selling into the academic research world has its downside (including significant sensitivity to government research budgets), but companies like Illumina (Nasdaq:ILMN) have done quite well serving the needs of the genomics market. I'm not suggesting that FEI is the next Illumina, but I do believe the opportunity in life sciences is currently underestimated.
SEE: Will It Be Even Harder For Life Tech To Muddle Through In 2013?
The Bottom Line
FEI isn't a household name, but some very smart investors have sizable positions in the stock. Not so surprisingly, then, it's not a screaming bargain today. Even if FEI can grow its revenue at a mid-to-high single-digit rate (fairly strong for an analytical tools company) and bring its free cash flow margin into the mid-teens, the fair value suggested by DCF analysts is in the mid-$60s.
There are worse things than paying fair value for a well-run company that serves multiple growing markets. Even so, I'd be careful chasing this stock near its 52-week high and would instead prefer to wait in the hope of a pullback.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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