Mixed-signal and Radio Frequency (RF) semiconductor manufacturer CML Microsystems (LSE: CML) has released an upbeat trading update today. It shows that the company is on track to meet full-year expectations. However, its shares lack appeal. Here’s why.
CML’s sales for the first half of the year are around £13m. This includes a two-month contribution of product revenues from the acquisition of Sicomm of £0.4m. Pre-tax profit is expected to be around £1.9m in the first half of the year and the company’s cash generation continues to be healthy. In fact, as at 30 September, CML has net cash of over £11m. This should provide it with sufficient capital to continue to grow over the medium-to-long term.
CML should also benefit from the relatively high quality and reliability of its technology. This helps to create a competitive advantage in its two highly niche markets of industrial storage and communications. It should allow CML to continue to deliver improved financial performance. And with further investment in R&D, CML has a bright future.
In fact, CML is expected to grow its bottom line by 5% in the current year. While this is a positive outlook for the company, its valuation appears to more than adequately price-in its future potential. For example, CML trades on a price-to-earnings (P/E) ratio of 20.9. In itself, this is expensive but when combined with CML’s growth rate it shows that the company lacks a margin of safety. Â
For example, its price-to-earnings growth (PEG) ratio is 4.2. This shows that the company is priced as a growth stock but as far as the current year goes, it lacks the double-digit growth outlook such a high valuation demands.
Of course, CML is set to perform well as a business beyond the current year. It’s well-placed within its markets to deliver further increases in profitability. However, following its 18% share price rise in the last three months, it now lacks appeal compared to sector peers such as Imagination Technologies (LSE: IMG).
Growth ahead
Imagination Technologies has endured a very difficult period that culminated in a loss last year. However, it’s on track to return to profitability in the current year and is expected to grow its bottom line by 34% in the next financial year. Although it trades on an even higher P/E ratio than CML, Imagination Technologies’ rating of 44 equates to a PEG ratio of 1.3 when combined with its forecast growth rate.
As such, Imagination Technologies has a wider margin of safety than CML. Although its near-term prospects remain uncertain due to the challenges it has faced in recent months, its valuation appears to price this in. It may not pay a dividend over the medium term as it returns to full health, while CML yields 2% from a dividend covered 2.6 times by profit. However, Imagination Technologies’ bright outlook means that dividend growth in the long run could be rapid.