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Stock Screen: Value Line Financial Strength Changes - January 2, 2013
Value Line assigns Financial Strength ratings across a spectrum from A++ (Highest) to C (Lowest). Generally speaking, the largest companies with the strongest balance sheets get the highest scores. Factors considered in making a rating determination include balance sheet strength, corporate performance, market capitalization, stability of returns, and business outlook, among others.
The Financial Strength rating and a stock’s Price Stability rank are the two main components used to determine Value Line’s proprietary Safety Rank, which measures the total risk of a stock relative to the approximately 1,700 other stocks under Value Line review.
Although a company’s Financial Strength rating is just one factor among many that investors should consider, it is an important one. Moreover, shareholders should take particular note of changes in this rating—both up and down. Value Line subscribers have access to our complete list of Financial Strength upgrades and downgrades each week in the Selection & Opinion section of the product. Noted here, however, are recent upgrades awarded to Brocade Communication Systems (BRCD) and Kulicke & Soffa Industries (KLIC).
Brocade Communication Systems
Brocade Communication Systems develops, markets, and sells a line of switches and software for connecting computer servers and storage devices through fiber channel and enterprise networks. These connections allow companies to share storage in Storage Area Networks that offer high security, high performance, reliability, and scalability.
Brocade has introduced some promising new technologies, its most notable being virtual cluster switching (VCS), which appears to be a major breakthrough for the data center industry. Management thinks that VCS will increase the adoption rate of fully virtualized, cloud-enabled data centers. Another key offering is a 100-gigabyte router that is designed to facilitate the tremendous growth of network traffic that many of Brocade’s customers are now facing. We also believe that sales of new 16-gigabyte products to some major OEMs will help shore up results in the Storage Area Network division.
We look for earnings to continue to recover in fiscal 2013. The operating margin is poised to improve, thanks to relatively high markups on the Data Storage Products division’s latest offerings, as well as new operating efficiencies.
Over the longer term, we look for decent top- and bottom-line annual growth. In addition to recent product launches, Brocade might well continue to benefit from rising global technology spending. This will likely be the case, assuming strengthening global economic conditions over the 3- to 5-year pull.
We have recently increased the Financial Strength Rating for Brocade from C++, to B. This largely reflects the company’s improving bottom-line performance, coupled with a stronger financial position. Debt-to-total capital is currently at a manageable level, while cash on the balance sheet is sizable. Management has utilized this cash hoard to buy back shares in recent months. We look for this endeavor to continue moving forward, which should help boost shareholder returns.
Kulicke & Soffa Industries
Kulicke & Soffa supplies production equipment to manufacture, assemble, and test semiconductor devices. Assembly equipment products include wire bonders (92% of sales) and packaging materials (8%). Foreign sales account for 98% of the total. Research and development costs equaled 8% of the top line in fiscal 2012.
The current fiscal year, which ends September 28th, 2013, could prove to be a challenging one. Lingering macroeconomic concerns, combined with excess supply capacity in the chip industry, might well lead to a decrease in outsourced semiconductor assembly and test (OSAT) demand. Lower utilization rates might well cause customers to delay their capital spending.
That said, healthy long-term fundamentals remain intact, reflecting overall solid demand for mobile devices. What’s more, the current industrywide transition from gold to copper ball bonders is likely to be a key intermediate-term driver. Indeed, the company’s leading market position in copper bonders should provide a valuable competitive advantage going forward.
Management continues to pare costs in the current lackluster demand environment. More specifically, it recently implemented a cost-cutting program designed to decrease discretionary operating expenses. Furthermore, it moved its wedge bonder manufacturing to lower-cost, Asia-based facilities.
We have boosted Kulicke’s Financial Strength rating from C+ to B, given the company’s improved financial standing. Kulicke has no debt on the ledger, while cash on hand is currently more than $5.85 a share (around half the share price). Though earnings per share are likely to dip in the current fiscal year, we believe this is due to broader economic factors, and is not related to company-specific concerns.
At the time of this writing, the author did not have any positions in any of the companies mentioned.