Go Defensive with this Tech Stock

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As industries turn to smaller and more complex chips, chip makers have to enhance their production processes. Chips are designed and tested in electronic design automation systems. One of the leaders in this market is Synopsys (NASDAQ: SNPS). In recent quarterly results, Synopsys generated net income of $0.66 per share, beating analysts’ estimates by 5%. The stock is up 15% year-to-date, rising at a slightly faster pace than competitors’ stocks. Both Mentor Graphics (NASDAQ: MENT) and Cadence Design Systems (NASDAQ: CDNS) are up 12% year-to-date.

Is this sector interesting?

The environment for electronic design automation systems remains challenging due to the weakness of the world economy and softness in semiconductors. Despite this fact, chip producers have to produce new chips, and, therefore, have to design and test them.

Synopsys’ net income grew 32% year-over-year, while revenue rose 15.5%. The net income of Cadence Design Systems grew 30% year-over-year, while revenue rose 12%. Mentor Graphics saw a 17% decline in revenue. You can see that income growth outpaces the growth of revenue. This is in line with what you might have expected in this environment. While it’s difficult to substantially grow the volume of transactions, companies strive to optimize their performance on the cost front. For example, Synopsys has lowered its operating expenses by 1% year-over-year. In fact, it managed to increase its research and development expenses by 12.4% while cutting administrative expenses by 35%.

Why should you be interested in this sector? The companies that provide electronic design automation systems are essential to chip makers and the world can’t go without chips. You should not expect sky-high performance in this sector, but neither should you expect huge drops.

Valuation

Synopsis trades at a 14.40 forward P/E, while Mentor Graphics trades at a 11.11 forward P/E and Cadence Design Systems trades at a 14.83 forward P/E. Synopsis operates at 13% margin, while Mentor Graphics has 13.15% operating margin and Cadence Design Systems has 16.45% operating margin. Turning to debt, Cadence Design Systems has most debt with a 0.44 debt-to-equity ratio. Mentor Graphics has a 0.21 debt-to-equity ratio, while Synopsis has virtually no debt with a 0.04 debt-to-equity ratio. As you can see, the companies in this sector are mostly in line with each other in terms of valuation and stock performance.

Synopsis has a solid cash position with $681 million in cash and cash equivalents as of the most recent quarter. Cadence Design Systems boasts good liquidity too, with $810 million of cash. Mentor Graphics is weaker on cash than its counterparts with $206 billion in cash and cash equivalents.

Synopsis has a business partner it can rely on. During last quarter, the company has renewed a significant multiyear agreement with Intel. Synopsis also boasts a large semiconductor company which had been a competitor stronghold for years moved to Synopsis as their main partner. In newer industries, the tide lifts all boats, but in a mature industry, you'd be better off picking the leader. 

Bottom line

What can you expect from Synopsys? The company is attractively valued, however, it operates in a sector that faces significant headwinds. Analysts' mean target price for Synopsys is $41.17, a 13% upside from current levels. Its biggest client, Intel, is having a good year, both as a company and as a stock. Synopsys could make it into the defensive part of your portfolio as we head into the post-quantitative easing environment. 

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.


Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure