Short Term Setback Provides Good Entry Point Zygo Corporation (NASDAQ: ZIGO)

Short Term Setback Provides Good Entry Point Zygo Corporation (NASDAQ: ZIGO)

Zygo Corporation (NASDAQ: ZIGO) is a designer and manufacturer of high-end optical systems and components for metrology and end-user applications. Its business is divided into segments: Metrology Solutions and Optical Systems Division. The Metrology Solutions consists of products that employ different optical phase analysis. On the other hand, its Optical Systems manages optical design, assembly and high volume manufacturing of precision optical components and systems. Given the recovery in the business activity in the semiconductor sector, this a small cap stock worth looking at.

It reported last month that its net income for the first quarter of 2013 amounted to $2.4 million, or equivalent to per share earnings of $0.13. This is a decline from the previous year’s net income of $6.5 million, yielding to earnings per share of $0.35. Revenues came in at $40.2 million, also lower than the $44 million revenues in the comparable prior year. While this seems like a disappointing first quarter results, this is a temporary situation for the company.

It decided to pursue shift in product line as well as customer mix. This will enable them to mitigate slower demand in the semiconductor industry. As a result, gross margins were lower during the period with a significant change in product mix in both metrology and optics segment. However, it ramped up its new optics program to diversify its product lines. Also, net income declined after an accounting reversal related to its previous tax provisions. The allowance against deferred tax assets were eliminated as the company improved its operating performance and business outlook. Hence, Zygo’s fundamentals remain intact and the latest quarterly result represents a short term setback for the company.  

For the last 5 years, earnings per share have grown by 23.08% a year. This is in contrast to the industry’s earnings decline of 3% a year. Operating margins has also increased from 5-year average operating margin of 1.61% to trailing operating margins of 15%. This is attributed to management’s constant effort to review its product and customer mix over time.

With this good track, it’s safe to say that Zygo can post double digit gains over the next 5 years. In fact, it is growing its footprint in strong regional markets such as Germany and Taiwan. For the year, it opened its Taiwan subsidiary to provide local sales and support for its Asian clients. It will make a significant investment in facility and additional qualified resources to support its customer in the backend semiconductor inspection market for PC substrate and IC packages. This subsidiary will play an important role throughout the Asia region.

During the year, it has received major orders from top-tiered clients. For example, Zygo was awarded an order valued at more than $3 million from a major medical device to produce high precision lens assemblies. At present, it has a total backlog of $65 million compared to the previous year’s backlog of $60 million. This assures investors of revenue visibility moving forward.

The stock trades at 7 times earnings. This is lower than its historical earnings multiple band of 8 to 9 times. The reason is that investors tend to look at short term results rather than the long-term economic prospects of the company. Investors can see this as a good opportunity to pick up a good semiconductor stock with strong future prospects.