GENNUM CORP. $11.50 (Toronto symbol GND; Aggressive Growth Portfolio, Manufacturing & Industry sector; SI Rating: Above average) is the highest rated stock in the bunch. It makes chips that enhance the quality of video signals, mostly for major TV display makers and broadcasters. This business supplies two-thirds of its revenue. Gennum also makes audio chips for hearing aids and headsets.
Demand for high-definition TV sets is growing fast, and Gennum has won several new video chip contracts in the past year. The company’s new audio headsets, which help filter excess sounds in noisy environments, also have great potential.
The company is free of long-term debt and has a healthy record of earnings. But its small size may make some investors wonder if it can live up to its potential.
Gennum’s stock has moved down from $18 in January, partly due to the high Canadian dollar. It sells 90% of its products outside of Canada, and our rising dollar hurts its revenue and profit.
In its second fiscal quarter ended May 31, 2006, the company’s revenue rose 2.2%, to $37.1 million from $36.3 million a year earlier. If not for the higher Canadian dollar, revenue would have been $3.3 million higher. Earnings fell 7.7%, to $0.12 a share (total $4.5 million) from $0.13 a share ($4.8 million).
Gennum continues to spend heavily on research, particularly as it replaces its older analog chips with digital versions. Research costs in the most recent quarter fell 5.7%, to $11.5 million (31.1% of revenue) from $12.2 million (33.8% of revenue) a year earlier. The company must write off these costs immediately, which makes it look much less profitable than it really is.
The stock now trades at 21.7 times the $0.53 a share it will likely earn in fiscal 2006. But Gennum’s earnings in fiscal 2007 could rise to $0.77, and the stock trades at 14.9 times that estimate. The company’s balance sheet is also strong. It’s debt free, and has $36.3 million ($1.01 a share) in cash.
Gennum’s low price and attractive technology could turn it into a takeover target. However, investors should treat a company’s takeover potential as a bonus, and not the sole reason to invest.
Gennum recently hired a new CEO with lengthy experience in the chip industry. That should help it exploit its competitive advantages, and avoid getting mowed down in the years ahead by larger competitors.
Gennum is a buy.
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