Chips will be a major ingredient of the transition to net-zero emissions, helping power the electric vehicles and smart infrastructure that will reduce emissions and curb global warming. Lately, though, chips have been on a roller-coaster ride.
That’s highlighting the charms of some of the semiconductor companies that will play critical roles in the carbon transition. One beneficiary of the march to net zero is Teradyne (TER), which makes testing equipment for chipmakers.
Among other things, Teradyne equipment tests chips that make cars powered by internal combustion engines more efficient, and help power electric cars, subways, trains, and buses. Meanwhile, Teradyne’s robots inspect and maintain commercial wind turbines and help reduce the risk of human injury in warehouses.
We found Teradyne by sifting through the Morningstar US Sustainability Moat Focus index. The index currently contains 62 stocks with low-to-medium environmental, social, and governance risk, all with Wide Morningstar Economic Moat Ratings. The ratings and fair value estimates are determined through independent research conducted by the Morningstar equity research team.
Because the index focuses on companies with moats, it excludes some carbon-transition darlings like solar companies. We sorted the companies by cheapness, as expressed by discounts to fair value. So far this year, through June 29, Teradyne is up around 25%, handily beating the Morningstar Global Markets index at 12%. It also has a low ESG Risk Rating, yet it trades at 70% of fair value. What gives?
In April, Teradyne’s first-quarter report showed that declines for its wireless and system test businesses appeared steeper than Morningstar had previously forecast. First-quarter sales declined 18% from a year earlier, with declines in every end market, including systems test, wireless test, and robotics segments amid a downturn in the hard-disk-drive market and weakness in mobile devices and global industrial demand. Nevertheless, demand remained strong in the automotive and industrial chip markets.
What is it, and Why Does it Have a Moat?
Teradyne is one of two companies worldwide that can produce testers for the most cutting-edge semiconductors – the other being Advantest (ATEYY). As such, it provides testing solutions for nearly every semiconductor under the sun.
Morningstar analyst William Kerwin says: “Teradyne’s ability to design testing equipment for bleeding-edge chips is the biggest driver of its competitive advantage, representing intangible assets that we don’t think are easily replicable.”
That makes it a vital supplier to chipmakers. In particular, it has extremely strong relationships with Apple (AAPL) and Taiwan Semiconductor (2330).
“It dominates its industry,” Kerwin says in an interview. “It’s unique on the back end.”
Teradyne also sells what are called ‘collaborative robots’ and self-driving vehicles for factories and warehouses, and this dominance has produced robust returns. Kerwin notes that in particular, its market leadership exhibits itself in industry-leading margins, strong returns on invested capital, and a top market share.
More pluses: Teradyne’s ability to generate free cash flow in a capital-intensive business, and its use of extra cash to bolster its market position in robots and other businesses. It had $859 million in cash on March 31. As of the first quarter, semi test accounted for 67% of revenue, robotics for 14.4%, system test for 12.1%, and wireless test for 6.3%.
Teradyne’s Sustainability
Teradyne’s ESG risk is low, according to Morningstar Sustainalytics. Human capital is its biggest material risk. Mirela Lupu, ESG research team lead, technology, media and telecommunications for Morningstar Sustainalytics, ticks off Teradyne’s charms. Lupu notes that management has anticipated and addressed potential ESG problems and is also “disclosing a lot” on ESG measures.
Teradyne’s financial strength also gives management ammunition to address any additional ESG risks that may arise.
“Because the company has strong financial performance, it’s more prepared to mitigate risk,” says Lupa. Indeed, Sustainalytics dubs Teradyne in the top-rated companies in its industry in terms of ESG risk.
By 2025, Teradyne aims to achieve 100% renewable energy. One of the key focus areas is targeting its operations in the Philippines, which accounts for a large chunk of emissions. It reports emissions and other data to the Carbon Disclosure Project annually.
The company also has other solutions for global warming: its robots maintain wind turbines and support waste reduction, which Teradyne says gives companies “the ability to adapt to consumer needs while avoiding waste and overproduction”.
What’s Next?
Over the long haul, Teradyne’s prospects look bright. Speaking at a JP Morgan conference in May, Rick Burns, Teradyne’s president of semiconductor test, said three key technologies are driving automotive demand: autonomous driving, high voltage technology, and battery management.
More chips and increasingly complicated uses and packaging mean more testing. Teradyne is a “beneficiary of a tectonic shift to a computing era, with tens of billions of Internet of Things devices shipping annually,” Jefferies analysts wrote. For products such as robotics, “these applications have zero-defect requirements”.
Kerwin expects Teradyne’s results to bottom out this year, and to see “an immense rebound in 2024″ as chip test demand revives. The company has said it expects earnings per share of $7.50 to $10 in fiscal 2026. That suggests double-digit compound annual growth.
He states: “Investors will require patience for 2023, but we reaffirm our belief that shares of this testing behemoth are seriously undervalued.”
