I'm going way off the beaten path to highlight two beaten-down growth stocks today. MKS Instruments(NASDAQ: MKSI) and Trex(NYSE: TREX) aren't household names by any means. But they each have a long history of growth and strong shareholder returns -- the present downturn notwithstanding.
To be clear, it's not surprising to see these two stocks trading down. MKS Instruments made a very questionable acquisition, and Trex is facing a cyclical drop in consumer demand. Both of these problems could persist for the next year or more, weighing down shares. But thinking bigger picture, I believe both stocks are worth investors' attention.
1. MKS Instruments
Perhaps readers are aware of Lam Research and Applied Materials -- two rivals that make machines for manufacturing semiconductors. These two companies just so happen to be MKS Instruments' two biggest customers. The company makes subsystems that are crucial to the semiconductor manufacturing industry. In fact, management claims that nearly all semiconductors worldwide are made with the help of MKS Instruments' various products.
In its annual report, MKS Instruments management says, "The market for our products is cyclical and highly competitive." I'll address each concern in turn.
The chart below shows both the cyclical nature of MKS Instruments' business and the market's typical response to a downturn. Note that it doesn't appear like the company is experiencing a downturn with revenue near an all-time high. But organic revenue is down; overall revenue has simply been boosted by its $5.1 billion acquisition of Atotech last year.
As a result of the present downturn in the semiconductor cycle, the valuation of MKS Instruments' stock plunged as it has in times past. But this time, the price-to-sales (P/S) valuation dropped to an all-time low.
Turning from cyclicality to competition, MKS Instruments frequently acquires other companies to ensure it has the products its customers are looking for. It notes that "historical customer relationships" and "breadth of product line" are two ways to fend off competition. Its acquisition of Atotech did help in that regard by giving it products to better address the further miniaturization of semiconductors.
However, acquiring a large competitor in a cyclical downturn and when interest rates are rising may have been an untimely move. Revenue in the third quarter of 2023 was down 7% year over year in spite of the boost from Atotech. Interest expenses are up due to its elevated debt load. And the company even took an excruciating $1.8 billion goodwill impairment charge earlier in 2023.
Here's the good news for investors today: MKS Instruments is still very relevant and will rebound when the industry rebounds; the long-term demand for semiconductors remains. Moreover, the goodwill charge was non-cash and a one-time event. The company is otherwise profitable in 2023.
Over the last decade, MKS Instruments has averaged an operating margin of about 19% -- higher in good years and lower in bad years. But considering the company's current revenue run rate of about $4 billion, it should be more than capable of generating $1 billion in annual operating income in the future. With a current market capitalization of just $5.3 billion, that's an attractive valuation for those who can patiently wait for the rebound.
The semiconductor cycle may need time before it improves. And the same might be said about the housing cycle that's negatively impacting composite-decking company Trex at the moment. Homeowners are more likely to upgrade their outdoor spaces with Trex's premium decking products when home values are rising. But higher mortgage rates are keeping home values in check in 2022 and 2023.
In 2022, Trex's revenue plummeted as its distribution channels reduced their inventories. Production lines consequently weren't running at full capacity, and this hit its profit margins.
The story has been better in 2023. Trex's production lines still aren't operating at full capacity. However, through the first three quarters of 2023, the company's net income of $183 million is up from net income of $175 million in the comparable period of 2022. Its profits are up even though its year-to-date revenue is down almost 2%.
Trex's management found ways to reduce its costs in 2023, which is why it's profits are up. This continues the long-term trend for Trex, as the chart below shows, and it demonstrates why this is a business to invest in for the long haul -- it's an excellent operator.
With revenue stabilizing and a clear demonstration of ongoing operational excellence, I believe investors can safely invest in Trex stock here. It may take a while for home values to start climbing again and meaningfully increase demand for the company's products. But trying to perfectly time demand cycles isn't a realistic thing for investors to shoot for.
Where to put that $2,000 in available cash
Regarding whether one should invest $2,000 in MKS Instruments stock, Trex stock, both, or split a $2,000 investment between the two, that's entirely up to each individual. This is because portfolio and budget considerations are entirely personal. My point is that for investors looking for stocks to add to their portfolios, these two could make valuable contributions.
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