AEIS - Advanced Energy Industries: Near-Term Demand Uncertainty But Long-Term Growth And A Decent Valuation

2023-09-26 11:10:16 ET

Summary

• Despite potential risks from weaker demand for semi capex and industrial end-markets, AEIS offers leverage to chip manufacturing complexity and opportunities in AI, automation, medical equipment, and renewable energy.
• My earlier concerns about share loss to a rival no longer seem as pressing, and AEIS has leading-edge products for sub-2nm chip production that should ramp in 2025 and beyond.
• AEIS shares have outperformed rivals and customers, and even with some near-term uncertainty on semi capex demand, mid single-digit long-term revenue growth can support a fair value in the $120's today.

Forecasting the ups and downs of the cyclical semiconductor and semiconductor equipment industries has never been easy, but having followed the industries for almost 30 years now, I feel like it's become even more challenging with even more moving parts (and the growth of AI and auto semiconductor usage only adds to it). Now, add on top of that the challenges of forecasting industrial cycles and data center investment cycles, and the modeling process for Advanced Energy Industries (AEIS) is certainly not simple.

All of that said, while I do see some risk of weaker than expected semi capex demand over the next 12 months, as well as weaker industrial end-markets (particularly automation), I like AEIS's leverage to increasing chip manufacturing complexity and the demand opportunities created by AI. I also like the leverage to growth markets like automation, medical equipment, and renewable energy.

AEIS shares are up more than 20% since my last update , outperforming rivals like Comet Holdings (COTN.SW) and XP Power (XPP.L), as well as key customers like Applied Materials (AMAT) and Lam Research (LRCX). With the shares having already pulled back about 20% from their high this year, I think this is a name to consider even with the uncertainties in end-market demand over the next few quarters.

More Stories Of Push-Outs, But Demand Should Recover In Due Time

Uncertainty remains the word of the day for the semiconductor equipment space that represents AEIS's biggest end-market, and it's not as though the multiple industrial end-markets that the company also serves are doing markedly better.

There have been plenty of reports of fabs pushing out orders for equipment, particularly at older nodes, and the memory space has definitely been weak, but I think (as does AEIS management and the managements at large customers like Lam) we've passed the worst. I do see some risks in logic over the next few quarters on weaker auto and industrial markets, but companies there like Analog Devices (ADI) have commented recently that cancellations and push-out requests have been lightening up. While semiconductor lead-times are still at historically high levels, there have been some big corrections (40%-plus in some cases) from 2022 peaks.

At the same time, companies continue to invest in capacity for next-gen chips, including looking ahead to sub-2nm architectures and new 3D structures like gate-all-around (or GAA). That in particular should be a positive for AEIS as these new chips will require even more precise plasma management and involve more steps - all of which should drive demand for the company's newest eVos and eVerest plasma power offerings.

Even with emerging opportunities like GAA and the ongoing growth in AI, I don't think 2024 will be a particularly sharp rebound, but I do think 2025 will be quite a bit stronger as new offerings that are currently in the evaluation stage (particular for etch and deposition stages) convert to full commercial ramps and grow from there. Likewise, I see strong multiyear growth tied to trends like electrification (factory automation, passenger vehicles, renewables), AI, and IoT.

There's A Lot Of AI Hype, But There's Also Real Growth Potential Tied To It

I won't dispute the idea that AI has become one of the new hot topics and that usually means that a lot of companies with iffy leverage to AI spending will get hyped up by analysts and investors looking to leverage that sentiment. In the case of AEIS, though, I think there are legitimate drivers.

For starters, hyperscale AI investments are real, and that's going to drive a lot of silicon demand, including leading-edge chips whose more complicated manufacturing demands will drive demand for AEIS's most advanced systems. At the same time, there are a lot of other chips that go into AI-centric data centers, and that, too, will help fuel demand for AEIS systems from capital equipment manufacturers like AMAT and LRCX.

There's also a second meaningful angle to AEIS's AI exposure - the data center power supply business. AEIS has done a good job of recruiting hyperscale customers and AI-centric data centers are notoriously power-hungry (consuming around 3x to 5x more power). With that, not only do these data center operators need highly reliable power supplies, they need systems and solutions that maximize efficiency, and that likewise speaks to AEIS's expertise - the company's 48V products carry higher ASPs and margins for the company, but reduce current draw, conduction losses, and heat generation for DC operators.

Industrial Demand Is A Risk, But Medical Can Help Offset This

I do have concerns about near-term demand for the company's industrial power supply and control products. Automation orders have been trailing off markedly and I think it could get worse before it gets better. Likewise, I do see some risks to the outlook for customers in areas like hard coatings and analytical instruments as uncertainties around the near-term economic outlook (the UAW strike, a possible government shutdown, the election cycle in 2024, tighter credit, inflation, et al) could lead to a longer period of capex deferral and slower overall demand.

Offsetting that, AEIS has really stepped up its efforts to grow its medical power supply business, including the acquisition of SL Power Electronics. While I wouldn't characterize the current environment for hospital capex as a blockbuster, it's healthy and I think there will be a multiyear capex catchup process as hospitals shift gears and return to capital projects that were canceled or delayed by the needs and disruptions of the pandemic (as well as component and staffing shortages that followed).

Longer term, I like this segment, though it's an area where management execution has not always been as consistent as I'd like to see. I see no reason why durable medical equipment won't be a mid-single-digit growth opportunity (with share growth opportunities for AEIS), and I'm even more bullish on opportunities like factory automation and renewables (solar and micro-grids).

The Outlook

When I last wrote about AEIS, one of my major concerns was the possibility that the company was losing share to Comet. That seems to be less of an issue now, and it does suggest that AEIS has possibly been regaining share (in RF particularly) and/or Comet's relative strength was a byproduct of leverage to different customers and segments (like memory) relative to AEIS's mix. I still think the relative performance of the two companies merits ongoing vigilance, but it does seem as though Comet's performance correlates more closely with memory relative to AEIS.

This year (2023) is almost certain to be a down year for AEIS, and I think a double-digit year-over-year revenue decline is still possible. Business should rebound in 2024, though, and I expect a double-digit acceleration in 2025 on stronger semi capex demand, an industrial capex recovery, and the maturation of new evaluation-stage products for advanced semiconductor processes. Long term, I'm modeling around 5%-6% annualized revenue growth, as the company should be well-placed to benefit from semiconductor volume growth, as well as further growth in DC spending and electrification of factories and commercial buildings.

As business recovers, low-to-mid-20%'s EBITDA margins should again be attainable, and I'm expecting long-term free cash flow margins in the mid-teens (drive double-digit FCF growth). Management has made it clear that growth is the number one priority for capital deployment, so don't look for big commitments to buybacks or dividends in the near term.

Discounted cash flow suggests a fair value in the $120's today and a solid double-digit long-term annualized potential return. Multiples-based valuation is trickier; you won't get a particularly useful result using current margins given the correction in the semiconductor business, but at a certain point projecting out too far becomes a "choose your own outcome" exercise. Should AEIS get back to a low-20%'s EBTIDA in FY'25 (23.5%, say), that would support a 2.35x forward revenue multiple and fair value (discounted back) in the low $120's.

The Bottom Line

Timing cyclical businesses is never easy, and there's definitely a risk that buying AEIS today is buying in ahead of a longer/sharper decline in semi capex demand - many management teams have indicated that they think Q2'23 was the bottom and that they will see a gradual recovery from here, but investors who've followed this space long enough know that even the best-intentioned guides can prove inaccurate. Even so, I think today's valuation is fairly undemanding for a company that has been improving and has attractive long-term leverage to growth in semiconductors (including AI), data centers, medical equipment, and factory automation.

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