Tuesday, September 27, 2011

Data I/O ( Nasdaq - DAIO ) -- Fundamentals Intact

Data I/O (DAIO $4.75) appears on track to report excellent on target Q3 results.  The stock has declined 25% in price over the past two months, reflecting soft demand for semiconductor manufacturing equipment in general.  Data I/O probably is selling fewer new systems than it would under more dynamic economic conditions.  Business remains good, all the same.  Recent software introductions have improved the underlying equipment's competitive advantage.  Data I/O is the leading producer of systems that load data onto virgin computer chips so they can be used in the real world.  Flash chips for smart phones and tablets are a major end market.  The company also is a leader in providing automotive computer chips.  Both of those segments continue to expand. 

Data I/O also has begun selling its new software packages to its installed base.  Those highly profitable sales promise to widen margins in upcoming periods.  Inventory fluctuations, which hit the semiconductor industry after the Japanese earthquakes, may be causing customers to hesitate when placing new orders.  A decline in the overall economy probably will continue to keep sales below potential over the next 6-9 months, as well.  But the combination of market share gains and new high margin software sales promise to keep income moving higher even during the dark days.  Bigger gains are likely when conditions improve in 2012. 

Technically, hedge fund selling has exacerbated the stock's recent falloff.  That overhang may continue to weigh on the price.  Looking past that short term pressure, the long term outlook remains bright.  Large as it is, the semiconductor industry remains in an early stage of development.  Data I/O is well positioned to keep gaining market share as it boosts productivity, and perhaps makes complementary acquisitions with its cash horde.  In 2-3 years earnings could reach $.75 a share.  Applying a P/E multiple of 20x suggests a target price of $15 a share, potential appreciation of 215% from the current quote.

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