Markets & Finance

How Keithley Instruments Measures Up


By Richard Tortoriello Many research scientists and engineers know of Keithley Instruments (KEI), a maker of measurement systems for high-performance production testing, process monitoring, product development, and research. But since the technology slump began in early 2000, this small-cap stock has fallen off many investors' radar screens.

Indeed, it's understandable that investors are currently avoiding the technology sector as more bad news from chip giant Intel (INTC) and others roil the market. But we at S&P think that this small-cap maker of electronic instruments will catch the eye of investors as a tech rebound gains strength and earnings rebound. We currently have a 4-STARS (accumulate) recommendation on Keithley shares.

Solon (Ohio)-based Keithley is far from a typical high-tech outfit. Founded in a small Cleveland workshop in 1946 by Joseph F. Keithley (the father of current CEO), it focused on supplying test and measurement equipment to research scientists. Now, it also sells advanced electronic test equipment to the semiconductor, optoelectronics, and wireless communications markets.

CORE FOCUS. The Keithley brand is known and respected worldwide. Its products have been used by Nobel laureates and are used by national metrology labs worldwide to maintain precision standards. It competes with a number of companies in specialized test-and-measurement markets and one large measurement-products supplier, Agilent Technologies (A).

In recent years, KEI sold two noncore businesses as part of a strategic plan to expand its core electronic test-and-measurement products and target three high-growth areas: telecommunications, optoelectronics, and semiconductors. In fiscal year 2001 (ended in September), despite a sharp downturn in each of these markets, semiconductor manufacturing provided 31% of revenues, telecommunications accounted for 12%, and optoelectronics contributed 14%. Keithley's traditional education, research, and electronic components and subassembly markets still provide a significant portion of the company's revenues, accounting for 43% of sales in fiscal year 2001.

Keithley sells a broad range of products that test, measure, and analyze electrical and physical properties. Products include stand-alone "bench-top" instruments for measurement and testing in a variety of electronics industries, PC plug-in boards for process control and data-collection applications, integrated test systems used to monitor semiconductor manufacturing processes and characterize chips, and test systems for wireless devices and fiber-optic networks. Selling prices range from $200 for computer plug-in boards to $400,000 for standalone semiconductor test systems.

IN THE CHIPS. Keithley has started enhancing its traditional products by equipping them with Ethernet connectivity, allowing instruments to be controlled, and data collected, from anywhere on a network. Keithley also is targeting its research and development (R&D) funds for radio frequency (RF) test and measurement, an increasingly critical application amid the rise of wireless communications. Direct current (DC) power test and measurement -- necessary for the growing number of portable electronic applications -- is also an area of focus.

As with many companies that serve the communications and semiconductor markets, Keithley's revenues have suffered severely during the downturn. Recently, however, signs of growth have emerged in the semiconductor market, including falling chip inventory levels, rising prices, and increasing chip-manufacturing capacity utilization (utilization jumped to 76% in the first quarter of 2002, from 66% in the fourth quarter). Keithley's semiconductor orders increased in the March quarter for the first time in five quarters. Overall, orders for the March quarter rose by 13% vs. the prior quarter.

While telecommunications and optoelectronics markets remain weak, the long-term outlook for both remain positive as demand for networked applications and wireless communications rises. S&P expects the wireless handset market to grow 8% this year, and by 10% to 15% during the following years. In addition, newer wireless applications, such as wireless local area networks (LANs), should spur higher overall growth in this market. We expect growth in the optoelectronics market to resume later, beginning in 2003. Keithley continues to expand its product lines in these areas.

OWNER AT THE HELM. Keithley's business has significant barriers to entry. Its product line is the result of decades of research and development. Keithley regularly spends 10% to 15% of sales on R&D, as well as collaborating closely with customers. The company also stays on top of leading-edge technology trends through its strong relationships with research institutions and industrial research labs.

Of the semiconductor equipment-related companies followed by Standard & Poor's, Keithley has the highest average gross profit margins and the second-highest level of return on equity (Novellus Systems is No. 1). Three-year gross margins have averaged 60%, while three-year average return-on-equity is 26%. Over the past five years, return on assets, a measure of how much profit management has been able to squeeze out of every dollar of assets, has averaged 9%. What's more, the company's balance sheet is solid, with virtually no debt and nearly and $2.70 per share in cash.

Another positive: Management has a significant interest in the company. Chairman and CEO Joseph P. Keithley owns a 14% stake, and other executives and directors own an additional 4%. We like the idea that the company is run by an owner vs. a hired hand.

ACCUMULATE ON WEAKNESS. We project earnings growth will proceed slowly over the next few quarters, however, as improvements in the semiconductor and industrial markets are offset by continued weakness in communications. We see a loss per share of $0.20 in fiscal year 2002 (ending September). But then we estimate EPS of $0.43 in fiscal year 2003 and about $1.25 in fiscal year 2004.

The stock, at its recent price of $16.90, currently sells at 2.7 times trailing sales and 2.2 times our calendar 2003 sales estimate, a discount to peers in the semiconductor equipment group.

We have a six-to-twelve month price target of $25, and we recommend that investors accumulate the shares on weakness. Analyst Tortoriello follows semiconductor equipment stocks for Standard & Poor's


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