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Two Top Stocks for 2010


If they're appropriate for your risk profile, jump in.

FormFactor has been hit by a double-whammy the last couple of years. The memory industry went through its own excess capacity shakeout coupled with the normal capital spending reductions of a cyclical downturn. Estimates of capital spending by memory manufacturers for 2009 are at the lowest level in the last seven years. Worse, the capex-to-revenue ratio for the industry (a commonly used metric) is at a record low. Consequently, fundamentals have been a disaster for more than a year and the firm's been through some deep restructuring.

Top-line "growth" remains negative and gross margin for the nine months ending September 30 is a meager 2.3%. It goes without saying that operating income has been more of a fantasy than a reality during this period.

So what's so attractive about FormFactor at this point?

Unlike some other types of wafer fab equipment, the demand for wafer probe cards is not primarily dependent upon new capacity expansion plans (i.e. new fabs or new lines within existing fabs). On the contrary, process technology changes (i.e. shrinks) drive demand and that's where you'll see the bulk of capital spending in 2010. For example, Micron's technology partners in Taiwan (Nanya and Inotera) are both undergoing shrinks as they shift to Micron's stack process.

FormFactor is also a primary beneficiary of technology developments within product groups. The shift to DDR3 from DDR2 is currently taking place among DRAM suppliers. That drives new demand and will throughout next year. On the NAND side, higher densities and more bits per cell all spur growth for FORM.

Lastly, a new suite of products for DRAM and NAND flash are said to enable higher tester throughput and will extend the life of the tools for the OEM. I've checked with at least one fab on this subject and the feeling is that the efficiency claims are valid. Every fab manager likes to save money!

Given the extraordinarily weak demand environment over the last year or so, coupled with the changes I expect in the memory market next year, I think the opportunity for topline growth in 2010 is very real. If that can happen, what's the potential?

Take a look back at FormFactor's fundamentals earlier this decade in the table below. The company consistently reported gross margins approaching 50%. As part of the current restructuring, manufacturing operations are being moved to Asia so it's possible with lower costs the prior metrics may be exceeded. That's not going to happen tomorrow but the potential for margin expansion from current levels (16.8% FQ3) is extraordinary. Operating margins were consistently in double-digits and should return to those levels again as well.

Currently, about 45% of the company's market capitalization is net cash (about $9.30 per share) with no debt. Granted, it's been burning cash in this downturn but a little more discipline in its working capital accounts should address most of that issue and a little topline growth would take care of the rest.

FormFactor's stock has lagged most other wafer fab equipment companies on a year-to-date basis, so this one hasn't run away from you. Do some work on the name and, if it's appropriate for your risk profile, jump in.
Position in MU
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