Veeco: U.S. government could be wildcard for China tailwind (VECO) | Private Equity Weekly

Veco Instruments (NASDAQ: Veco), a semiconductor process equipment supplier, released its latest Form 10-K, closing its accounts for fiscal year 2023. Overall, fiscal 2023 was a great year for VECO, with the company returning to the stock with strong gains.In fact, Vico The company was able to grow revenue and profits at a time when most suppliers of equipment used to make semiconductors were shrinking due to a downturn in the equipment market. Granted, VECO isn’t a pure-play semiconductor company, but it’s the semiconductor segment that’s driven its outperformance, offsetting weakness elsewhere. However, there’s more to this stellar performance, which puts it in a different light. As for why, we will talk about it next.

VECO is in the midst of a rally

A previous rally rated VECO a Hold after noting some contradictory aspects of the stock.superior On the one hand, the stock rose on the back of strong profits in a tough market. On the other hand, the article also notes that short interest in VECO has been unexpectedly high, far exceeding what one would expect from a company with no obvious flaws.

This raises the question why the bears decided to short VECO.According to the latest data NasdaqAs of February 15, short interest stood at 6,274,000 shares, an increase from this year and equivalent to 11.5% of the short float. It’s impossible to know what motivates every short, but the fact that there are so many is reason enough to take a closer look at VECO before going all out.

In terms of the stock itself, there are certainly reasons to be long VECO. The chart above shows how the stock soared after bottoming in May 2023. The stock was worth $17.70 in May 2023, but now VECO is worth more than twice that, with the stock closing at $36.90 on March 1, 2024. Or momentum is what matters, then long-term VECO has a strong argument to support it.

How VECO excels

VECO has other arrows in its quiver. VECO has performed better than other companies because it has managed to sustain growth when other companies have failed, which is another argument in favor of VECO in the long term.Sources vary, but according to recent SEMI reportIn 2023, global semiconductor manufacturing equipment sales will decrease by 6.1% annually to US$100B.

In comparison, VECO’s fiscal 2023 revenue increased 3.1% annually to $666.4 million, and non-GAAP earnings per share increased 7.6% annually to $1.69. On a GAAP basis, VECO ended up with a net loss of $30.4 million, or $0.56 per share, but this was the result of debt refinancing. Additionally, fiscal 2022 GAAP income of $166.9 million benefited from a $117 million income tax benefit, which brought fiscal 2022 fourth quarter GAAP income to $128.9 million, or $2.00 per share, skewing the year-over-year comparison.

Semiconductor revenue contributed US$413 million, accounting for 62% of total revenue, with an annual increase of 12%. Science revenue contributed US$78 million, accounting for 12%, and increased by 15% year-on-year. These two revenues helped offset declines in compound revenue and data storage revenue, which each accounted for 13% share. As of fiscal 2023, VECO had $305.8 million in cash, cash equivalents, restricted cash and short-term investments, partially offset by $274.9 million of long-term debt on the balance sheet. The table below shows the numbers for fiscal 2023 versus fiscal 2022.

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source: VECO Form 10-K

Guidance calls for revenue in the first quarter of fiscal 2024 to be US$160-180 million, a 10.8% increase from the same period last year. GAAP earnings per share are forecast to be US$0.22-0.33, an annual increase of 61.8%, and non-GAAP earnings per share are forecast to be US$0.36-0.46, an annual increase of 36.7%.

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source: VECO Form 8-K

For comparison, the table below shows numbers from previous seasons. Note that without strong contributions from the semiconductor sector, these numbers would have been much worse. For example, in the fourth quarter of fiscal 2023, semiconductor revenue increased 17% quarter-on-quarter, offsetting weakness in other regions.

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Source: VECO Form 8-K

What to expect from VECO in fiscal year 2024

VECO offers some insight into what lies ahead beyond the first season. VECO expects revenue in fiscal year 2024 to be US$680-740 million, with annual growth of 2.0-11.0%, non-GAAP earnings per share of US$1.60-1.90, and high-end annual growth of up to 12.4%. From the fourth-quarter earnings call:

“Now for some additional colors outside of Q1. Based on our current expectations, we reiterate our 2024 revenue outlook in the range of $680 million to $740 million. Based on the scheduled shipment timing of our backlog and forecast orders, we Second-half revenue is expected to exceed first-half revenue. We continue to forecast full-year non-GAAP diluted earnings per share to be in the range of $1.60 to $1.90.”

Source: VECO Earnings Conference Call

If VECO were at the midpoint, that would imply a forward non-GAAP P/E ratio of 21.1x, EPS of $1.75, and a stock price of $36.90. This is higher than VECO’s average of 17.6x over the past five years, but lower than the industry median of 25x.

Is there anything I should be aware of with VECO?

On the surface, there aren’t many obstacles to VECO’s long-term growth. The income statement and balance sheet both look good. VECO is growing, but it’s doing so in a depressed market. If the market returns to growth, as many expect, VECO will be in a stronger position. The chart points in the direction of rising stock prices. The multiples are not unreasonable. In short, there are a lot of people in favor of being long VECO.

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Source: Form 10-K

However, there is one issue that should cause concern. Recent growth has been driven almost entirely by China. While VECO was able to grow, demand in most markets declined. VECO would not have grown were it not for the huge growth in sales in China. China contributed 19%, or $123.7 million, of revenue in fiscal 2022, but that jumped to 33%, or $217.9 million, in fiscal 2023, after revenue growth of 76% year-over-year offset weakness elsewhere ). The table above shows how much China is an outlier that contributes to VECO’s recent results.

Should VECO be worried that China’s tailwind might reverse for some reason?

China has always been a driving force for VECO. However, we need to ask whether or how long this tailwind will last. The fact that orders from China increased so much, as much as 76%, while orders from other countries were much smaller, suggests that recent orders are being driven not just by actual demand but also by inventory building.

Keep in mind that the U.S. government has imposed trade restrictions on China, some of which apply to VECO, particularly those related to any EUV or cutting-edge technology. Most of the products supplied by VECO can be sold to China, but this may change in the future. Therefore, Chinese customers are motivated to order more products to hedge against possible supply chain disruptions with additional inventory. This may be the driving force behind the strong sales growth in China, which also allows VECO to perform well in a less than ideal market.

VECO currently supplies equipment for mature process nodes to China and has a senior official Ministry of Commerce It recently stated that the U.S. government has no interest in extending export controls to mature or legacy chips. However, the U.S. Department of Commerce reserves the right to change its mind, and even if it does, it won’t be the first time.

Recall how export controls have become increasingly strict. For example, early on, export controls were limited to 10 nm or smaller process nodes, but they gradually became more stringent as additional rules were added. For example, there are now rules that apply to the 16/14nm process nodes that did not exist before. A precedent has been set, and the U.S. government may decide to impose export controls on products currently sold to China, which may include most of VECO’s products sold to China.

For example, the U.S. government recently License canceled Previously, the company had authorized Entegris (ENTG) to ship certain materials to customers in China, allowing ENTG to do business with the customers in question. The U.S. government occasionally changes its mind, so the possibility of VECO being deprived of trade with China at some point in the future cannot be ruled out. Considering how much growth is coming from China in the first place, that’s not a good thing for VECO.

Important points for investors

There is a lot to be said for long VECO. VECO’s ability to grow in a difficult market is impressive, especially when most companies fail to do so. VECO isn’t expensive, and its forward price-to-earnings ratio of 21 times is lower than most in the industry expect. The chart shows that going long VECO is the right choice.

But China deserves attention as a growth driver. VECO did outperform, but its growth is misleading. Without increased orders from China, revenue and profits will almost certainly shrink in fiscal 2023. China’s 76% year-over-year sales growth masked double-digit weakness elsewhere. The fact that China is the only reason VECO will grow in fiscal 2023 makes us look at its outperformance in a very different light, and not in a good way. This raises doubts about the sustainability of this outperformance.

Granted, this exposure doesn’t necessarily have to be a problem, especially in the short term. The U.S. government can allow trade to continue, as it has recently stated, and VECO can continue to benefit accordingly, but if the U.S. government decides to change its mind again and impose trade restrictions where it currently does not, VECO may see its The tailwind turned into a headwind.

It’s tempting to go long VECO since it has so many advantages, but given the above, I’m neutral on VECO. VECO looks poised to build on its results, but U.S. government policy is a wildcard that could disrupt everything. If the U.S. government doesn’t intervene, the recent trend is likely to continue, but if it does, the bears may have the last laugh, taking a hit from the stock market rally as they ramp up their bets.